New Delhi: Reserve Bank of India (RBI) governor Raghuram Rajan on Monday said the world is facing an “increasingly dangerous situation” and a new international agreement on the lines of Bretton Woods is needed to prevent central banks from adopting policies that could hurt other economies.
“What I have in mind (is that we) will eventually require a new international agreement along the lines of Bretton Woods, and some reinterpretation of the mandates of internationally influential central banks,” he said in a commentary posted on the website of Project Syndicate.
He said central banks in developed countries find “all sorts of ways” to justify their policies, without acknowledging the unmentionable—that the exchange rate may be the primary channel of transmission.
“If so, what we need are monetary rules that prevent a central bank’s domestic mandate from trumping a country’s international responsibility,” Rajan said.
Setting the rules will take time, he said, adding the international community has a choice. “We can pretend all is well with the global monetary non-system and hope that nothing goes spectacularly wrong. Or we can start building a system fit for the integrated world of the twenty-first century,” Rajan added.
He said the world is facing an increasingly dangerous situation and both advanced and emerging economies need to grow in order to ease domestic political tensions. “If governments respond by enacting policies that divert growth from other countries, this ‘beggar my neighbour’ tactic will simply foster instability elsewhere. What we need, therefore, are new rules of the game,” Rajan said.
The Bretton Woods conference led to the setting up of the International Monetary Fund (IMF) and the World Bank. He said that to bring growth back to pre-2008 levels, the remedy may be to write down the debt to revive demand.
“It is uncertain whether write-downs are politically feasible or the resulting demand sustainable. Moreover, structural factors like population ageing and low productivity growth—which were previously masked by debt-fuelled demand—may be hampering the recovery,” Rajan said.
Politicians, he said, know that structural reforms to increase competition, foster innovation, and drive institutional change are the way to tackle structural impediments to growth. “But they know that, while the pain from reform is immediate, gains are typically delayed and their beneficiaries uncertain,” Rajan added.
All monetary policies have external “spillover” effects, Rajan said, adding circumstances today are, however, not normal and domestic demand may not respond to unconventional policy.
“To use a traffic analogy, policies with few adverse spillovers should be rated ‘green’; those that should be used temporarily could be rated ‘orange’; and policies that should be avoided at all times would be ‘red’. He said globally countries are far from having clear agreement on the colour of policies today, even with the best data, models, and empirical work.
“So we must begin a discussion. We could start with background papers from eminent academics and move on to multilateral institutions such as the International Monetary Fund and the G-20. There will be a lot of fuzziness initially, but discussion will lead in time to better models and data—and will push policymakers to stay out of the clearly red,” Rajan said.
Central bankers face a different problem: inflation that is flirting with the lower bound of their mandate. “With interest rates already very low, advanced economies’ central bankers know that they must go beyond ordinary monetary policy, or lose credibility on inflation. They feel that they cannot claim to be out of tools.
“If all else fails, there is always the ‘helicopter drop’ whereby the central bank prints money and sprays it on the streets to create inflation,” he added.
He admitted that setting such a rule will take time. “But the international community has a choice. We can pretend all is well with the global monetary non-system and hope that nothing goes spectacularly wrong. Or we can start building a system fit for the integrated world of the 21st century”.