RBI governor Dr. Raghuram Rajan in his speech in Brookings on 10th April 2014 exhorted central bankers from the Fed to the ECB to acknowledge that their actions had widespread repercussions amongst emerging economies. He urged them to think of the consequences of unconventional monetary policies on emerging economies. Dr. Rajan has been defending the Indian Rupee after the Fed opened up on its plans to taper its quantative easing program.
The Fed, ECB, Bank of Japan and Bank of England are adopting ultra loose accommodative policy by keeping interest rates at record lows and pumping in money into the system through asset purchases and refinance operations. Understandably there is concern amongst emerging central banks on the effects of withdrawal of the ultra loose policies.
Dr. Rajan has suggested that central banks adopt a wider approach to policy framework that takes into account the consequences of their actions on other economies.
The previous Fed chairman, Ben Bernanke was quick to point out that unconventional monetary policies are essential in times of need and the Fed and other central banks do talk to central bankers around the world explaining their policies.
Dr. Rajan is right in airing his views on unconventional monetary policies as it does open up debate on the efficacies and side effects of such policies. However asking the Fed or ECB to weigh the consequences of their policies on other economies is like asking the Indian Government to weigh its subsidy policy on the economy!!
The Fed wants a robust job market before it steers away from unconventional policy. The ECB is fighting the spectre of deflation and is considering quantative easing. The Fed, ECB and other central banks are fighting economic issues in their own countries and would first look to set that right before even thinking of other economies around the world.
Yes, in normal circumstances, central banks can coordinate actions but in abnormal circumstances such as the one the world is in right now post the financial crisis in 2007-08, it is each one for himself or herself.
What is the line of defence for countries like India on spill over effects of global central bank unconventional monetary policies? The only line of defence is fundamentally strong fiscal and monetary policy. The government’s fiscal policy should aim at strengthening the country’s finances and keep down inflation expectations. RBI’s policy should be to keep down inflation expectations and strengthening the banking system framework so that the system is not affected by a global market debacle.
India suffered when the Fed in May 2013 spoke about withdrawing stimulus. The country was grappling with record high current account deficit, rising inflation expectations and government finances that were weak leading to high market borrowings to fund the fiscal deficit. The Rupee fell over 20% to record lows against the USD, forcing the government and RBI to take steps to lower current account deficit, bring down inflation expectations and keep borrowings in check.
RBI is doing its job in keeping down inflation expectations by adopting a conservative policy stance despite economic growth coming off to decade low levels. Will the new government that takes office in May 2014 do its job by keeping down deficits and inflation expectations?
It is vital for the macro economy to strengthen in India as Fed unwinds stimulus even as other central banks pursue stimulus and unwind it later on. Indian can then easily ward off the consequences of unconventional monetary policy.