Ashima Goyal of IGIDR writes this amazing paper on the topic. Apart from monetary policy, it has this nice coverage on developments in economy and financial markets since independence.

The study examines and assesses monetary policy in India after independence in the context of interplay between domestic structure and external factors. Domestic structure includes economic and political structure, the demands of growth, poverty reduction, financial inclusion and the gradual development of institutions and markets. The external sector includes the dominant ideas of the time and their change, shocks such as oil and wars, dependence on foreign capital and the effect of greater opening out. Structure and ideas become engraved in institutions that affect outcomes. Instead of the structure, conduct, performance (SCP) paradigm used in the industrial organization literature, this is a SIIO paradigm.

In the study, narrative history, data analysis, and reporting of research are used to show the dialectic between ideas and structure. Policy outcomes are explained in the framework developed. Given the six decades over which the dialectic has played out, a broad brush approach is used that focuses on the main trends, rather than the day-today policy decisions that co-created the trends. But a flavour is given of intricate processes that generate the cold numbers.

It is argued a greater congruence between ideas and structure in recent times contributed to improvements in institutions and to India‘s better performance. Policy moved from struggling with scarcity to having to deal with excess foreign exchange. Automatic financing of government deficits gave way to more independence for the Reserve Bank, but political pressures led to a uniquely Indian balancing between reducing inflation yet promoting growth. The distinctive feature of the study is it is not an official history like those currently available, but an independent academic work, that is closer to the international and to Indian academic literature, while it draws on the Indian experience largely from published materials, including official records.+

It has this nice discussion on how global economic thought influenced India’s policymaking – the journey from Keynes to New Keynesian models.

Keynes: Keynesianism ruled in 1950s but in India’s case govt. expenditure was justified as India suffered from huge supply constraints. However, this reasoning was lost out post Mahalonobis plans and adoption or USSR model. Wide restrictions were placed on foreign stuff and import substitution was preferred.

Monetarism: This picked up in 1970s. Friedman’s Quantity theory of money (QTM) became accepted and attempts were made to estimate money base. money multiplier etc.

Globalization and new ideas: As central banks moved to interest rates, RBI did as well. Though it was tough early on as in India we had administrative rates in all sectors. The transition from admin rates to market determined rates was not easy. RBI played a central role

The best section of the paper deals with relation of RBI with government and RBI’s independence. RBI was set up as an independent entity but soon became like a department in FinMin:

Pre independence the discussion preceding the setting up of the RBI emphasized the importance of setting up an institution free of political influence. There was a debate, but even those on opposite sides agreed on the importance of at least instrument independence. Under the pre-independence RBI Act it was obligated to carry out the responsibilities laid on it by Statute. It was nationalized at independence, but under the constitution and the division of responsibilities, if the RBI said no to the finance minister, the government would have to go to Parliament, which could assert some discipline. But the early view of planning as a national goal established precedents and procedures that vitiated the autonomy of the RBI. The initial jockeying between the RBI and the Ministry of Finance13 made it clear the RBI was to be regarded as a department of the government. Monetary policy was another instrument to achieve national goals. The RBI lost even instrument independence. RBI accepted govt. demand to create debt monetisation: An example of such a precedent was the RBI‘s agreement to the Government‘s January 1955 proposal to create ad hoc treasury bills to maintain the Government‘s cash balances at 50 crores or above, thus making soft credit available to the government in unlimited quantities. With the aid of this facility, the issue of ad hocs rose during the second plan. The Government also reduced safeguards restricting currency expansion. The RBI‘s early conservative CB stance changed by the second Plan to one that supported the Government‘s financing requirements. By 1967 the heterodox 1951 Yojana Bhavan perspective on monetary policy had become the orthodox RBI view—it had adopted and internalized the opposite government view. Where the Government pulled the RBI found itself following. The government wanted lower interest rates given its large borrowings, and this made it difficult for the RBI to raise rates. The RBI early showed itself to be susceptible to pressures to support government borrowing through the Gsecs. Even in 1951 banks were given an exemption from showing capital losses from their holdings of Gsecs on their balance sheets (Balachandran, 1998, pp. 55). As manager of the government debt the RBI generally sought to support the government borrowing program. The stance of independence also depended on the Governor in charge. Some Governors clashed with the government like PC Bhattacharya (1962-67), LK JHa (1967 to 1970) etc. The 1991 crisis and persistent monetization of deficits led to ending ad hoc t-bills and WMA was started in 1997 to manage short-term mismatches. Then came FRBM in 2003 which tied the hands of the government (though not fully true). There is a nice table at page 32 where RBI Governors are compared across many variables (a similar comparison made by this blog here). Table 7 shows growth, inflation and monetary policy have differed in the tenures of various Reserve Bank governors. The overall direction may have been dictated by the preferences of the elected government, given lack of constitutional autonomy. But the delegated agent, or the Governor, has been able to make a difference. The divergence in performance in the regimes of different governors suggests that their preferences affected growth rates. Second, governors in whose regime growth was higher have delivered lower inflation, since cost shocks normally sparked higher inflation, but the monetary response affected growth and future inflation. Short-run sharp inflation caused by supply shocks was controlled through a fall in demand, but it harmed longer-term growth. The clear differences in regimes suggest that governors whose policies discouraged recovery in growth ended up with higher inflation also (Goyal, 2007). The two governors with the highest rates of growth of reserve money, Dr. Manmohan Singh and Dr. Reddy, also had local maxima in rates of growth and minima in rates of inflation. Hmmm.. The table is really interesting. Need to study it more indepth.. It then goes on to explain the changes in RBI’s monetary framework from monetary targeting to current new framework of one Repo rate. In then, fiscal policy has always been more powerful in India and has pushed mon pol to a corner: Money and monetary policy are slippery concepts, and reality is often not what it seems on a surface reading. But careful fact-based analysis can yield interesting insights. There is two-way causality between money and nominal income. But during large supply shocks, policy shocks can be treated as exogenous. Such shocks are used in this study to understand the structure of the economy. These suggest that policy was sometimes exceedingly tight when the fear, and the common understanding, was opposite: of a large monetary overhang. In focusing on financing the Government, rather than on domestic cycles, policy was procyclical—too accommodative in good times and tight in bad times. Fiscal dominance pushed monetary policy to be too tight or too loose to compensate. An intellectual climate that encouraged government intervention and advocated a big push for development favoured the dominance of fiscal policy. These ideas became embedded in institutions and created path dependence—it was difficult to break out on a new path. The balance of payments crisis and the change in intellectual ideas provided the opportunity. The initial swing was too much in favour of markets, but a series of international currency and financial crisis have helped to moderate orthodoxy. It has become possible to devise a middling through path that suits Indian democracy and structure. The global crisis evoked a refreshing and apt policy stance that helped the economy retain high growth. But improvements are still required in inflation management. It says after global fin crisis of 2007, India fared better as it had improved its policies and institutions. The future will see these years as transformative for India and its institutions. Sometimes the best haste is made slowly. Overall a superb paper. Goes into your reading list of monetary economics in India right away…