Let’s not shoot the messenger

Tags: Op-ed
Let’s not shoot the messenger
TRUE STORY: The reality is that since managing monetary policy globally is out of the question, all that’s left to manage are the frictions that arise from the monetary policy free-for-all. For many insiders, this is Rajan’s crime
International monetary cooperation has broken down.” With these words, Raghuram Rajan, governor of the Reserve Bank of India, set off a fire storm last week. Coming on top of the US Federal Reserve Board’s decision to further scale back its monetary stimulus and turmoil in the financial markets of many emerging markets, these comments have unleashed a wave of commentary. One former senior US official wrote, “Governor Rajan did a disservice to international monetary cooperation” and went on to spell out why. What’s going on in the genteel world of central banking? Is this a storm in a teacup?

In a long interview on Bloomberg TV, Rajan described the many domestic factors that influence his strategy for tackling inflation in India. He was very firm on the need for reforms at home. In fact, the overwhelming majority of his interview was given over to domestic matters. This wasn’t a full throttled screed against the west, which isn’t surprising given the governor’s deliberative style.

Given India’s growing integration into world markets, it wasn’t surprising that the changing global backdrop came up during the interview, leading to a short discussion on the impact of industrialised countries’ monetary policies on emerging markets. In that discussion, Rajan pointed out that emerging markets had been buffeted first by the wave of money that flowed out of the west with its monetary easing and now by flows in the opposite direction. He argued that central banks abroad weren’t considering the knock-on effects of their actions and that emerging markets were expected to adjust. All of this was exacerbated by investors paying little attention to national details, indiscriminately selling emerging market assets now that they’d gone into risk-off mode, as he put it.

Pick up any business newspaper these days and you’ll find discussions of exactly the factors the governor mentioned. So what’s the fuss? Well, it’s the punchline that ‘international monetary cooperation has broken down’ that makes waves. Why? Because since the global financial crisis began and the G8 was expanded to the G20, thereby bringing the large emerging markets into world’s leading counsels, we’re all supposed to be in this together, solving problems, cooperating. Rajan’s comments call into question this polite fiction.

For the 12 months that the G20 went into crisis mode starting in the third quarter of 2008, fear drove world leaders to take extensive stimulus measures at home and to refrain from taking high profile beggar-thy-neighbour steps. If by cooperation you mean the latter, then that happened. Still, this is a far cry from real cooperation when governments take account of the major knock-on effects of their actions on foreign economies. That never happened. Still, the impression of unity persisted. Governments of emerging markets went along with this not least because, at last, they’d gotten a seat at the big table.

Once massive quantitative easing started, however, the situation changed. The flood of money out of the US and, to a lesser degree, from Europe into emerging markets led the latter’s exchange rates to rise against the dollar, with adverse consequences for export performance. Brazil’s finance minister went public in mid-2010 accusing the US of starting a currency war. He took a lot of flak for that. Western policy remained unchanged and so Brasilia decided that if you can’t beat them, join them —and the Brazilian real was devalued. Now that the Federal Reserve Board has changed course not surprisingly investors are adjusting, and the process is going into reverse.

On this reading, it’s not that international monetary cooperation has broken down — it never seriously existed in the first place. Smiles, warm words, and photo opportunities aren’t cooperation, they’re little more than good manners. Maybe Rajan was being polite but the reality is that governments and their independent central banks have resisted —what they see as — international accords tying their hands on an important tool for managing economic crises. Having gotten their independence from the government, no central bank willingly seeks new constraints on its action.

The reality is that since managing monetary policy globally is out of the question, all that’s left to manage are the frictions that arise from the monetary policy free-for-all. For many insiders, this is Rajan’s crime. The very act of stating there is a problem begs questions about a solution, about change, and ultimately about who must adjust. These are awkward lines of inquiry for policymakers not used since the fall of the Bretton Woods to any limits to their room for manoeuvre on macroeconomic policy. Quite frankly, it will take an even bigger crisis to prompt any serious change here, as there are far too many entrenched interests with a stake in the present arrangements.

The last word, however, should go to Rajan. He warned that if foreign central banks didn’t take international knock-on effects into account, then emerging markets would adjust and the steps taken might not be to the liking of the industrialised countries. He didn’t spell out what those steps could be but the threat was there. Let’s see if ultimately New Delhi will roll over, like their Brazilian counterpart.

(The writer is a professor of international trade and economic development at University of St Gallen, Switzerland)


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