Rajan calls for greater scrutiny on competitive monetary policies

Says existing stimulus measures are not sustainable, reversible, and do not contribute really significantly

Reserve Bank of India (RBI) Governor Raghuram Rajan on Tuesday called for increasing global growth potential through structural reforms and domestic investment, rather than through competitive monetary policies.

“If I get my growth simply by depreciating my exchange rate and drawing growth from you, and not by creating more investment domestically, that’s the policy that needs to be examined more closely than policies where I get my growth partly by exchange rate depreciation, but partly because my investments are drawing some of your products,” said Rajan, at Goethe University Frankfurt.

He delivered keynote address on Rules of the Game in the Global Financial System at a joint event by the Research Center SAFE, the Center for Financial Studies and the Deutsche Bundesbank, Germany’s central bank.

This is not the first time Rajan criticised competitive monetary policies practiced by global central banks. As recently in June, the central bank governor warned of such beggar-thy-neighbour policies by central banks of developed countries. While countries such as US and Japan, as well as those in the European Union are engaged in quantitative easing, China has aggressively depreciated its currency to boost its exports.

According to the RBI governor, aggressive monetary policy easing has not helped the countries much. Even after seven years of accommodative monetary policies, savings rates have not fallen, but investments have fallen considerably.

“Everybody is saying money is free... then why haven’t investments picked up? And why haven’t savings fallen?” Rajan asked, adding, perhaps the real reason is that the slowdown is structural, or maybe the pre-crisis level of growth was too high and unsustainably fuelled by non-inflationary borrowing.

This also implies that the kinds of stimulus the global central banks undertook have not worked.

"Because the kind of stimulus we are doing, like the variety of method of quantitative easing, we are altering asset prices. There is a thought that this kind of stimulus is not sustainable and the boost in asset prices today will reverse when we raise interest rates eventually," Rajan said, adding that "this kind of stimulus is not sustainable, is reversible and therefore does not contribute really significantly".

"Rather, the answer to economic uncertaities faced by the world is in increasing growth potential. Besides, countries need more growth because they have made promises in good times. Government promises, coupled with debts that it owes, make it imperative to seek growth," Rajan added.

The responsibility falls on central banks to make sure that growth takes place and surely, the central banks still have potent tools in the form of unconventional monetary policies.

But such policies fail to serve their purpose if everybody else starts following such policies, which is the case now and should be checked.

"Is there a way we agree what is legitimate monetary policy globally and what is less legitimate? It's not that monetary polices that have negative spillover on other countries should be immediately ruled out. But policies that have sustained negative spillover effects should come under a stronger lens from international agencies," Rajan said in his address.