Rajan offers solution to global policy spillovers

RBI governor sketches rating system designed to hold central banks to account; frank discussion may be enough, he says, but tougher rules in the style of Bretton Woods are also an option
Raghuram Rajan. Photo: Vishal Kullarwar

Reserve Bank of India (RBI) governor Raghuram Rajan has outlined a plan designed to end the destabilising global effects of certain central bank policies.

Rajan has long been a vocal opponent of policies that send damaging shockwaves across borders, particularly quantitative easing and currency interventions, which, he argues, bring limited domestic benefits and force foreigners to bear heavy costs.

Having reiterated this argument in remarks to an International Monetary Fund conference in New Delhi on March 12, Rajan laid out a method for making central banks take heed of their peers when setting domestic policy.

Traffic lights

Our understanding of spillovers is still incomplete and does not allow "clear-cut identification", Rajan said, but as a starting point, policies could be sorted into "traffic light" categories of green, orange and red.

Green policies, which result in few spillovers or only beneficial ones, would include most "conventional" monetary policies, as long as they are not creating undue financial stability risks, he said.

We can pretend all is well with the global financial non-system and hope that nothing goes spectacularly wrong

Orange policies, permissible only as a short-run boost, would probably be those that increase net global welfare, but impose some negative spillovers.

Red policies, which would be banned completely, bring limited domestic benefits while imposing significant spillovers. If unconventional policies generate a "feeble" recovery at home, but large capital flows and asset-price bubbles in emerging economies, these could be deemed red, Rajan said.

Policies could also be red when examined in isolation, but green when accompanied by a commitment to roll them back quickly or when used in dire straits. "Overall, whether policies are rated red, green or orange would depend on a number of factors," he said.

'Eminent academics'

The RBI governor's goal is to build both an analytical framework for studying spillovers and a method of enforcing the ban on "red-rated" policies. The starting point would be to establish a group of "eminent academics" with "reasonable representation across the globe" to examine spillovers and report back.

Representation of emerging markets is clearly a key element. In a separate speech in New Delhi, also on March 12, Rajan bemoaned the dominance of international organisations from advanced economies, but said it was up to emerging markets to build the intellectual framework necessary for them to wield more "soft power".

With initial analysis complete and the issues clearer, central banks, when gathering in a forum such as the IMF or Bank for International Settlements, could begin to slot policies into the coloured categories, he said.

Inevitably, there will be a lot of "fuzziness", Rajan admitted. "But discussion can help participants understand both how the policies could be classified if we had better models and data, as well as how the models and data gathering can be improved."

Bretton Woods

"Perhaps free and frank discussion may be enough to get countries to adopt responsible policies," Rajan suggested. Or perhaps not: the debating stage may only be enough to achieve a clearer understanding of the problems, he noted, in which case more ambitious plans may be necessary.

To this end, Rajan envisaged an international conference, which "will have to deliberate on how international responsibilities can be woven into existing mandates". This could be done through smaller amendments to the IMF's 'Articles of Agreement', or something bolder, along the lines of the Bretton Woods system.

"The international community has a choice," Rajan added. "We can pretend all is well with the global financial non-system and hope that nothing goes spectacularly wrong, or we can start building a system for the integrated world of the twenty-first century. I do hope we can consider some initial steps."

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