Raghuram Rajan, the governor of the Reserve Bank of India, questions the unconventional monetary policies central banks are pursuing and claims that pushing down interest rates results in people saving rather than spending. Rajan’s views echo those who criticize central bank policies, which have included restraining digital currencies.
On leave from a teaching post at the University of Chicago, Rajan offered his insights during the International Monetary Fund (IMF) spring meeting in Washington, D.C. in an interview with MarketWatch.
A persistent critic of Fed quantitative easing, Rajan said raising rates at a measured pace would give other central banks room to change from unconventional policies when a recovery becomes evident. Rajan served as the chief economist of the IMF where he raised concerns about the risks to the financial system prior to the financial crisis.
Rajan is among those who have criticized central banks for implementing policies that create negative interest rates. Financial commentator Max Keiser has noted that the global financial system no longer possesses the productive capacity to generate enough income to sustain current asset value, according to CCN. And when “tomorrow” cannot be paid, the current financial regime will fail.
Rajan, in his remarks, did not specifically address digital currencies. But central banks, who are coming under scrutiny for various reasons, in some cases have attempted to control digital currencies.
Russia in 2014 announced plans to ban bitcoin, CCN reported. Last month, that country’s deputy minister of finance expressed hoped that a law calling for the criminalization of bitcoin will be passed to the lower chamber of the Russian Parliament before the end of the current session in August.
Recently, there have been signs of central banks taking a new approach to digital currency.
The People’s Bank of China (PBOC) announced that it will try to launch its own digital currency “as soon as possible,” CCN reported.
The Reserve Bank of Australia’s payments policy department recently revealed it has kept a watchful eye on the growth in demand for digital currencies and believe that Australia will have a central-bank-issued digital currency, CCN reported.
The Bank of England (BoE) has sought a centralized, completely central-bank controlled bitcoin clone in the form of a cryptocurrency called RSCoin, CCN reported.
India’s Rajan said the Fed should not wait until global conditions improve, despite a dismal IMF report on the global economic outlook. He said the report does not clarify what is keeping the economy slow seven or eight years past the financial crisis. Some say the problem is the debt while others say it is low productivity, and still others attribute it to population aging.
Rajan said the consensus holds that monetary policy has run its course.
“You already see we don’t fully understand the consequences of negative interest rates,” he said. “So I would argue that, certainly, monetary policy is probably not the policy answer any more, of choice.”
This leaves small-scale reforms that are known to have positive impacts in addition to larger-scale structural reforms that can have short-term negative effects. You also have fiscal policy in some countries, but what you spend money on matters since there is a lot of anxiety about the future.
Unless there is a “brain wave” of understanding of what’s completely occurring in the industrial world, a more pragmatic approach to growth is needed.
The IMF forecast indicates growth will be much stronger than what previously occurred, and end the year revising downward. The IMF and other observers believe we will make up for the missing growth when in fact this may not be possible. Rajan said the answer is not absolutely known.
Industrial countries’ central banks should consider whether easing is doing more harm than good. The benefits beyond a certain point are not clear while the costs of this “ultra-accommodative” phase will increase. Rajan wonders if the policies are preventing adjustments that need to occur.
“I know this has got a bad name, it is the ‘liquidationist’ or ‘Austrian’ view, but it is a very real question of whether we’ve allowed the adjustments to take place enough or whether we’re keeping too many inefficient firms alive.”
In regard to his concern about quantitative easing, Rajan discussed the “problem of the bridges.” When one builds a bridge, it must reach the other side. A bridge that relies on wealth effects must yield enough growth to justify the asset price rise that created the wealth effects. The alternative is to kick off the wealth effect, but in time, people discover the wealth is not materializing, and an asset price adjustment occurs. “I think the jury is still out on which one we’re going to go through.”
There is concern that the U.S. needs to do more or end up like Japan, but Rajan thinks the worry is misplaced. He said Japan, which had a bank-dominated economy, denied the need to “clean up” big bank losses, then cleaned up quickly. The banks did not have a business model following the clean up. The central Japanese problem was the aging population, but the forces that caused the crisis remain unclear.
The U.S., unlike Japan, doesn’t have the same aging population issue, and it “cleaned up” much faster. Which leaves the question as to why the U.S. economy is not growing faster.
Rajan said he agrees with the “secular stagnation” argument, which holds that things were in place even before the crisis. But what these factors are remains uncertain. Secular stagnation refers to slow growth over a long period that may have masked the debt bubble. The cause remains unclear.
Janet Yellen, Fed chairwoman, believes an accommodative approach is needed to the neutral interest rate, which is low by historical standards. Rajan said whatever the model, when inflation and investment are both very low, a neutral rate is seen as being needed to drive investment to build aggregate demand. Low inflation indicates weak aggregate demand in relation to supply.
It is also necessary to drive consumption since investment alone won’t drive growth. You want to reduce savings and drive investment to build demand, so investment and consumption work together.
Under such a model, the equilibrium interest rate is very negative. Pushing it down low enough will iron things out to a degree. But the question remains – does consumption act perversely in regard to interest rates past a certain point? This, according to Rajan, is an important point that a number of people are making. If you push interest rates below a certain point, income impacts become greater than the substitution effects.
The standard view is if you push rates low, people think it is better to consume than to save. But if a person has an end-of-life savings goal, the low interest rates make it hard to meet their savings goal. This motivates them to save more. Hence, it is the “perverse effect” of low interest rates.
The Fed is at the point where it needs to consider raising interest rates, according to Rajan.
He said he is not saying the Fed is not moving fast enough. He thinks the Fed is weighing matters reasonably. He is saying it is about time that as economies strengthen, “we get out of this period of exit.” He said we need to be careful in what we do to exit since the system has been stretched so much that abrupt action will break it.
Rajan said he is more worried about lending by the financial system than about the financial system being at risk. One worry is the system has retreated too much from “market making” due to liquidity regulation or all the capital charges. The second worry is that small and medium enterprises are starved for credit. Have we raised the regulation on risky assets to the degree they are even more starved?
Rajan said he has been accused of holding two views on cross-border lending. Capital flows are dangerous on one hand. At the same time, he says there is not enough cross-border lending. What he is actually saying is that cross-border capital flows and cross-border lending are positive in a measured way.
If cross-border lending and capital flows are steady and reliable, and they finance risk, that is positive. There is a lot of knowledge coming behind foreign capital in financing risk.
“Unthinking” foreign capital coming in due to optimism that proves false exists quickly, and it creates more volatility than other countries can take, Rajan noted. This is what the Fed should be careful about – not getting carried away with incoming capital, but rather encouraging the right types of incoming capital.
What may be missing is risk-bearing capital, which calls for a better understanding due to all the regulations. Rajan said the Fed needed to re-regulate the banks, but it went too far the other way.
“The question we have to ask now is have we regulated them properly or are there mismatches between what we desire of them and what we’ve done?”
He said risk capital is most likely at a premium in emerging markets. To the extent that it is offered from external sources, it is worth examining.
Noting that the Indian economy is the bright spot in the world economy, Rajan said it still needs to get to a satisfactory place. Things are improving to the point that medium-run growth potential is possible. Investment is gaining strongly, and there is a fair amount of macro stability.
The account deficit is near 1%, and the fiscal deficit has declined. The government is on a consolidation course. Inflation has fallen from 11% to under 5%. Interest rates have fallen, and there is an inflation-targeting framework in place.
But work remains. The government has rolled out a new bankruptcy code. A goods and services tax is in the works.
Last week, Rajan introduced a platform allowing mobile-to-mobile transfers among bank accounts. This is a public platform anyone can use. It is not owned by any company.
Asked to compare India to China, Rajan said India is about 10 years behind China when they began the reform process. He thinks India can catch up if it pursues the right goals. He said people admire China for how they manage to get things done. India needs to work hard and create the right infrastructure and the right human capital.
Rajan said he would not call his monetary policy “opportunistic easing.” As disinflation occurs, there is more room. In light of all the pushes and pulls in the world economy, it is possible to forecast, but it is not possible to know if the forecast will come true.
Images from Wikimedia and Facebook/Times of India.
Last modified (UTC): April 17, 2016 11:35