What works in central banking? Striking a balance between talk and action

This piece has been updated to correct an error in the previous version  Almost a decade ago, in September 2015, the Reserve Bank of India (RBI) had cut the policy repo rate by 50 basis points (bps) – twice the extent that was widely anticipated. The rate cut, the biggest in at least three years, brought down the repo rate to 6.75 per cent, the lowest in four and a half years. One basis point is a hundredth of a percentage point. 

At the post-monetary policy interaction with the media, when someone asked the then RBI governor, Raghuram Rajan, whether he was playing the role of Santa Claus (known for bringing gifts to children on the Christmas Eve) his response was: “I don’t know what you want to call me... Santa Claus... you want to call me hawk… I don’t know. I don’t go by this. My name is Raghuram Rajan, and I do what I do.”  Why did he cut the rate by 50 bps? “We want to make sure that the word sustainable and growth go together. Both are important. That’s why we used the room we had. But I don’t think we are excessively aggressive. We were not throwing out the Diwali bonus.”

 

The latest monetary policy has also gone for a 50-basis-point rate cut, double the anticipated reduction. It hasn’t stopped there. Beyond the rate cut, it has also gone for a cut in banks’ cash reserve ratio (CRR) – or the money that commercial banks keep with the banking regulator – besides changing the monetary policy stance from “accommodative” to “neutral”. 

Announcing the previous policy in April, the current RBI governor, Sanjay Malhotra, had said: “I am Sanjay, not Sanjaya of the Mahabharata, who can predict future rate actions.” 

Malhotra does not have the divya drishti (divine vision) to foresee distant happenings. His actions are based on what he sees and feels must be done now. In the past, we have seen both kinds of governors – one who would do what needs to be done and another who would wait for data to take actions in the future. 

As the dust is settling down on the June monetary policy, there is intense debate among economists and central bank watchers on the no-frills, no-nonsense, bold policy based on available data. 

Is this the right approach? Or, should a central banker be circumspect and not lay all cards on the table? This is particularly when there are too many uncertainties around. 

There are no rules of the game. There are central bank chiefs who take actions feeling the pebbles – cautious small steps as they move forward, as every bit is not known. And, there are also others who formulate policy based on what they see and feel at the current moment. Malhotra is of the latter kind. 

A few days after the policy, we got to know that consumer price index (CPI) -based inflation in May eased to 2.8 per cent from 3.2 per cent in April – the lowest in 75 months. Many say it could be close to 2.5 per cent in June. Is the change in the stance in just two months (it was made “accommodative” in April) in sync with the incoming inflation data? 

At the same time, despite the fall in food prices, the sudden spike in crude oil prices, after Israel launched a sweeping military operation on Iranian nuclear and military sites, may have an adverse impact on CPI-based inflation. Who knows? 

Not actions alone; even when it comes to language, we rarely see such candidness. Indeed, the new growth-inflation dynamics call for frontloading of rate cuts to support growth, but it is rare to hear an RBI governor saying: “After having reduced the policy repo rate by 100 bps in quick succession since February 2025, under the current circumstances, monetary policy is left with very limited space to support growth.” He does not seem in favour of saving the gun powder for another day. 

This brings us to the key question of silence or talk versus action in central banking. None can deny that central bankers should walk the talk as credibility is their currency. They cannot afford to say one thing and do another. If they do so, markets stop believing them and the monetary policy loses its bite. At the same, talking the currency up and/or bond yield down is also a widely accepted practice. 

Former Federal Reserve Chair Ben Barnanke once said: “Monetary policy is 98 per cent talk and 2 per cent action.” He was talking about the power of forward guidance or talking about future actions, another important ingredient of monetary policy.

  Malhotra has given it. He has said, after all actions, “monetary policy is left with very limited space to support growth”. 

Should we then infer that the ball is now in the government’s court for giving growth an impetus, if the RBI actions don’t bear fruit? And that there is no scope for another rate cut? 

In central banking, communication is as important as action, if not more. Remember European Central Bank (ECB) President Mario Draghi’s famous quote – “whatever it takes”? In July 2012, Draghi said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” Delivered during a time of crisis within the euro zone, this statement helped stabilise the single currency and prevent its collapse. 

In his post-policy media interaction, Malhotra made it clear that he does not believe in talking – his belief is in action.  

ECB’s Christine Lagarde has often been criticised for being too cautious in speech versus bold in action — her words sometimes lack the market-moving power of her predecessors. Bank of Japan Governor Kazuo Ueda has been ultra-cautious in communication, as the smallest signal could lead to massive yen or bond volatility. 

The then US Fed chairman, Paul Volcker, who broke the back of US inflation in the early 1980s by aggressively raising policy rates, had said: “The most important thing I have to do is to maintain the credibility of the Federal Reserve.” 

Alan Greenspan probably has the last word on communication. He had said: “If I seem unduly clear to you, you must have misunderstood what I said.” 

What works better? Probably a balance between talk and action. A central banker who only “does” without preparing the market risks shock and volatility. On the other hand, one who only “talks” without doing anything eventually loses credibility. 

The fight is not between “doer” and “talker”. Ideally, the central bankers should prepare the market, signal intentions transparently, and follow through — explain why they did what they did. Malhotra has done that. 

The RBI started cutting the policy rate in February. Between the first week of February, when it cut the rate by 25 bps to 6.25 per cent, and on the eve of the June policy (when the rate was 6 per cent, through another 25-basis-point cut in April), the one-year treasury bill yield dropped by close to 100 bps. The drop in the 10-year bond yield was about 30 bps. After an unexpectedly larger dose of rate cut, the 10-year yield has hardened by about 10 bps. Yield and bond prices move in opposite directions. 

Of course, the overnight rate is moving southwards, in sync with the policy rate. In other words, transmission is happening at the shorter end and not across the board. 

But, as they say, there is always a leg effect between policy action and its impact. We need to wait and watch. Flexibility is the key as economies evolve rapidly. A central banker may sound one way today and act in another way day after tomorrow — not because there is a lack of conviction, but because of the change in data. As long as a central banker is nimble-footed, there is no quarrel on actions. 

The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in. 

X: @TamalBandyo