Central banks need better coordination: Raghuram Rajan

At a time when emerging economies’ financial markets are seeing volatility, as central banks of developed nations unwind their expansionary monetary policies, Reserve Bank of India (RBI) Governor Raghuram Rajan has cautioned against unconventional monetary policies and exits from these without coordination between central banks.

The US Federal Reserve has started tapering its quantitative easing programme, the run-up to which made emerging markets, including India, jittery. Now, markets are showing signs of stability.

“The current non-system in international monetary policy is, in my view, a source of substantial risk, both to sustainable growth and to the financial sector. It is not an industrial country problem, nor an emerging market problem; it is a problem of collective action,” Rajan said in a speech at an event organised by the Institute of Monetary and Economic Studies, Bank of Japan, Tokyo, on Wednesday.

Rajan, a strong critic of unconventional monetary policies such as quantitative easing and keeping interest rates at near-zero level for long, said the sooner central banks recognised the importance of coordination, the more sustainable global growth would be.

He said exits from unconventional monetary policies weren’t easy, adding these posed a challenge to the emerging economies, owing to spill-over effects. On the dangers of mismanaged exits, Rajan said these would prompt fresh distortionary behaviour.

He added the lesson emerging markets had learnt from the recent turmoil was not expanding domestic demand and running large deficits. Also, these countries would try to maintain a competitive exchange rate and build reserves because “when trouble comes, you are on your own”.

“In a world with deficient aggregate demand, is this the message the international community wants to send?” he asked.

“Perhaps, the most vulnerable to the increased risk-taking in this integrated world are countries across the border. When monetary policies in large countries are extremely and unconventionally accommodative, capital flows into recipient countries tend to increase local leverage,” he said, adding exchange rate flexibility in recipient countries, in case of such exits, sometimes exacerbated booms, rather than slowing inflows.

“So, when source countries move to exit unconventional policies, some recipient countries are leveraged, imbalanced, and vulnerable to capital outflows.”

Emphasising the need for more coordination among central banks, Rajan said these banks shouldn’t just worry about immediate capital flows to other countries due to their policies, but consider longer-term reactions such as the competitive easing or sustained exchange intervention that would bring about. “This will allow central banks to pay more attention to spill-overs, even while staying within their domestic mandate.”