Raghuram Rajan questions his peers’ policies!

Recently the Center for Financial Studies (CFS) awarded the Deutsche Bank Prize in Financial Economics 2013 to Raghuram Rajan. He presented his recent research paper on monetary response after the crisis.

He started his keynote lecture by saying “we seem to be in a situation where we are doomed to inflate bubbles elsewhere to boost the domestic demand” to question the low interest rate, “whether ultra low interest rates are part of the solution or part of the problem”. He called central bankers as “heroes” for rescuing the world from the brink of the collapse but warned his (now) counterparts, they may not be addressed same for the second half of the crisis i.e. recovery, as growth is not as expected!

He accepted the fact that he doesn’t have answers to the questions, he is raising, but he would like ask the questions!

He goes on to question the usage of monetary policy (over targeted fiscal policy) to drive the growth with the help of ultra low interest rates. He argues retirees as well as other people (who used to spend before the crisis) may not start spending in ultra low interest regime. In fact they may start saving more because spenders are under the water of debt over burden due to the crisis and retirees may not be able to get anticipated returns in these ultra low rates. Also he mentioned about “debt fuelled demand” is highly localised by quoting different spending patterns of Las Vegas and New York.

Moving on he questioned the credibility of the central bankers’ forward guidance like keeping interest rates low either time bound or conditional (like unemployment) dependent. Since recently markets started questioning the guarantee of central banks credibility and their talk.

He talked about amount of tapering may not alter much in long term Fed’s bond holding portfolio, which in turn should not have much impact on bond stock and flow.  But in reality it is not happening as per theory.

Talking about Bank of Japan, he hoped the balancing act of raising inflation expectation not too high and not too rapidly while maintaining bond yields low so bond portfolios don’t get beaten up, BOJ will succeed.

Unintended consequences of unconventional monetary policy

He said unconventional monetary policies may be intended to take more risk from entities like insurance companies and other financial corporation’s but he is not sure about that risk taking translates into real risk taking in real economy! But unintended consequences like spill-over and capital flow to emerging markets leading to asset price boom in those countries might raise the question. Politicians in emerging markets may forego the countercyclical policies during the capital inflow phase.

Even in industrial countries, monetary policy doing too much may take away the pressure from government and politicians and their focus. Because when central bankers say monetary policy is the only game in town they become the only game in town as everybody else then willing to wait. Damned if you do and damned if you don’t!

Pointing at taper talk confusions, he said we should plan our exit when we enter into something! Because of this stress he thinks emerging markets may decide not to run current account deficit, build safe structure by building reserves, focus on export led growth.

He said we need to break the cycle of one crisis to other like Asian crisis to Industrial world crisis and back to emerging market crisis again.

He ended his presentation by saying “I think I posed more questions than answers, but that’s the state of my thinking”.