Rajan seeks global money policy coordination to prevent spillover

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Reserve Bank of India (RBI) governor Raghuram G Rajan expressed concern about prolonged use of unconventional monetary policies such as holding interest rates at near zero, quantitative easing or exchange intervention adopted by central banks of certain advanced countries and the financial risks arising on exiting from such policies without global co-ordination among central banks.

He put forth a case for international monetary policy co-ordination to prevent the spillover effects in the rest of the world.

In his remarks at a conference organised by the Bank of Japan-Institute of Monetary and Economic Studies on Monday, Rajan said, “The international rules of the game need to be revisited as the world has changed. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle.”

Rajan said that when source countries move to exit unconventional policies, some recipient countries are leveraged, imbalanced, and vulnerable to capital outflows.

Recipient countries are not being irrational when they protest both the initiation of unconventional policy as well as an exit whose pace is driven solely by conditions in the source country. Having become more vulnerable because of leverage and crowding, recipient countries may call for an exit whose pace and timing is responsive, at least in part, to conditions they face, said Rajan.

The conventional met­hod used by a central bank is to try to raise the amount of lending and activity in the economy indirectly by cutting interest rates.

Lower interest rates encourage people to spend, not save. But when interest rates can go no lower, a central bank's only option is to pump money into the economy directly. That is quantitative easing (QE). The way the central bank does this is by buying assets — usually government bonds — using money it has simply created out of thin air. Banks selling those bonds will then have "new" money in their accounts, which boosts the money supply. Since the global financial crisis in 2008, both the Bank of England and the US Federal Reserve have used the policy of quantitative easing (QE) to try to revive consumer spending and economic growth. Last year, Bank of Japan embarked on its own bond-buying enterprise to end more than a decade of deflation.

The Fed is in the midst of tapering its stimulative quantitative easing policy. Fed Chairman Janet Yellen expects the program to wind down steadily through 2014 and conclude by year-end, assuming the economy remains healthy. When the US Fed had announced tapering its quantitative easing programme, several emerging countries including India had witnessed market volatility.

While ideally unconventional monetary easing policies quantitative easing should be vetted by an independent multilateral agency for their spillover effects, the problem would be to find an impartial assessor and in case the policies are found reducing global welfare, enforcing the judgement on the country. Therefore a more modest proposal would be that central banks reduce the incentive for countries to engage in a repeat of substantial reserve accumulation by building stronger international safety nets.

An interesting proposal from the International Monetary Fund (IMF) is a liquidity line from the IMF, where countries are pre-qualified by the IMF and told (perhaps privately) how much of a line they would qualify for under current policy – with access limits revised every year after the Article IV discussions and any curtailment becoming effective six months later. Such a pushed line could overcome the problem that no country wants to approach the Fund because of the associated stigma, said Rajan.

He said that the current non-system in international monetary policy is a source of substantial risk, both to sustainable growth as well as to the financial sector. “It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. The sooner we recognise that, the more sustainable world growth we will have,” said Rajan.


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