Reserve Bank of India Governor Raghuram Rajan once again questioned the benefits of ultra low interest rates and appealed to developed nations to consider the spillover effects of their monetary policies.
He was speaking at the IMF/Government of India Conference on Advancing Asia.
Rajan said that central banks in developed nations had by now realized that that monetary policy cannot substitute for structural reforms and elevate growth potential.
Even as central bankers are flirting with ever more unconventional policies, Rajan said it was worth asking if these policies really move the economy towards the desired objective.
“Monetary policy works through the public’s expectations; if ever more aggressive policy convinces the public that calamity is around the corner, it may tempt large segments to save rather than spend,” Rajan said.
“The effect is magnified if there is a sense that the consequences of today’s policies will have to be reversed in the future at great cost to the system,” he said.
Rajan warned that the unconventional “quantitative easing” policy of buying assets such as long term bonds from domestic players may certainly lower long rates but may not have an effect on domestic investment if aggregate capacity utilization is low.
“Savers may respond to the increased distortion in asset prices by saving more. And if certain domestic institutional investors such as pension funds and insurance companies need long term bonds to meet their future claims, they may respond by buying such bonds in less distorted markets abroad,” he said. This in turn would put pressure on the domestic exchange rate, Rajan said.
Also, growth has become critical for both developed and developing nations, Rajan said, adding that long periods of slow growth would make the unemployed unemployable.
Rajan said the IMF members were under obligation to to assure orderly exchange arrangements and to promote a stable system of exchange rates.
He suggested that monetary policies should be rated according to the potential spillover effects they may have.
“Polices that are generally seen to have few adverse spillovers, and are even to be encouraged by the global community should be rated Green, policies that should be used temporarily and with care could be rated Orange, and policies that should be avoided at all times could be rated Red,” Rajan said.
You can read the entire speech by Governor Rajan here.