Wrong to say central banks always have a bazooka: Rajan

Cautioning against expecting too much from central banks, RBI Governor Raghuram Rajan has said it is wrong on their part also to always claim a 'bazooka' left up their sleeves, even as he asserted that life is "very difficult" in emerging markets.

In a panel discussion here on lessons learnt by the central bankers from the global financial crisis, he also took on the industrial nations for expecting the emerging markets to be "orthodox" in their monetary and economic policies at a time when they themselves have "thrown out the orthodoxy out of the window".

He was speaking at a panel discussion after the Per Jacobsson Foundation Lecture, delivered by JPMorgan Chase International Chairman Jacob Frenkel, on the occasion of the Bank for International Settlements (BIS) Annual General Meeting here.

The lecture took place on June 26, but its content has been made public now only. Those participating in the panel discussion included Bank of Mexico Governor Agustun Carstens and Bank of France Governor Francois Villeroy de Galhau.

The lecture took place within days of Rajan making public his decision that he would not opt for a second term as RBI Governor when his current three-year tenure ends on September 4.

Rajan, a former Chief Economist at IMF who is credited for predicting the global financial crisis, was here to attend the BIS Annual Meeting, as also a bi-monthly meeting of select central bankers from across the world here at BIS Tower.

Referring to Frenkel's lecture that talked about unconventional monetary policies and the central bankers not being the only game in the town, Rajan said the question at the heart of his talk appeared 'why is the populism popular'.

"In a way, he was making a desperate plea for orthodoxy and saying let's not abandon orthodox principles and I guess the converse of that is that populism has become popular.

"I think if you want to talk about the institutional and environmental situation which supported the orthodoxy, the 80s and 90s, one would guess that it was a society where the elites were respected, where there was a feeling that they could understand and interpret the policies for the masses.

"There was broadly a positive sum game... And actions were not interpreted as favouring one constituency versus another. There was a sense of coherence in the society, little more than today," he said.

Rajan further said that when there is trust in the elite and there is no common economic paradigm, a lot of competing paradigms come up, some of which contradict the laws of economics and very little trust is left in the institutions.

"Well, that's what we call an emerging market," he said.

"It's the kind of environment we have worked in the past and we have tried to change that to try and say that there are some broad principles, there are institutions that we should build and yes that some people can be trusted, the experts can be trusted. It takes time to do that.

"But my sense is that what the crisis has done is that in the industrial countries, created the kind of conditions that bring you back to the conditions we experienced in the emerging markets," he added.  

Explaining further, Rajan sought to compare the current scenario in industrial countries as a new situation, where policies do not seem to work as advertised, where one could argue that normal laws of economics do not apply and where elites were pushing these policies before they lost the reputation.

"There is a sense that they don't know so they could not be trusted. There is a zero sum game that if an immigrant comes he takes my pension away and if I give to this set, which is top 1 per cent or so, then I am going to lose out in the longer run.

"Therefore things have become much more complicated. The ability to get a coherent economic policy in this environment is much more limited that what we have been experiencing for so many years in the past.

"So, in that sense it creates an entirely new environment for the central banks. I think we have been seeing a little bit of this. There is always this notion that many of us have expressed that it can only be a part of the solution and the others would have to step up to the plate.

"What if others are paralysed and they cannot step up because the environment has changed tremendously. How much do you do? I think this is where Jacob's angst comes through.

"If I interpret what you say, you should have gone to a point, take a little bit of detour but should have come back. But these detours which seen longer term and long lasting, may be problematic in the longer run. I think that is what I hear you as saying.

"I think there are two issues here -- one, the whole belief in central banks that somebody else will step up to the plate is not being fulfilled. Second, something we are ourselves responsible for in the central banking community, the statement that we can do it.

"Just wait, we have one more tool up our sleeves. We aren't exhausted yet. There is always a bazooka left that we have not used. If we say that and at the same time, nothing else is coming up to the plate, then effectively we become the only game in town. How to move away from that is really quite difficult," he said.

On what policies one should follow in such an environment, Rajan said, "There is a tremendous political suspicion of the elites or the elite institutions and a sense that you really don't care for the masses and you are brought in and paid for the Wall Street or its equivalent in every country.

"One thing is to damn the torpedoes, if you are crudely orthodox you will say damn the torpedoes, I do so much and no more and then let the pieces fall where they will and this is how much I can do.

He further said, "My sense is that would be nice as per the orthodox principle but it won't be feasible in the kind of environment we are in. So, next is to say, let me try innovating and you come up with new solutions and some of them will work a little bit but not enough.

"Then the question is what more do yo do. At some point, you call stop, or you keep holding up the promise of something more and once you go down the list of instruments you pull out, the ratio of economics to politics keeps falling.

"Ultimately, you are doing it because the system won't let you stop. So, my sense is this is the reason why we are in this dilemma. The environment has changed a lot, but not the economic environment.

"The laws of environment applies broadly. ...  it is also that the political environment has changed and the respect for elites who focus on the economics and not on the broader section of population, at least that is the popular view, becomes very hard," he said.  

Talking about emerging markets in this kind of situation, the RBI Governor said spillovers become much more difficult in this kind of environment because the whole focus is on the domestic economy.

"What is the exit out of this kind of environment and the exit becomes much more harder when you focus domestically especially when one effective channel of transmission is the exchange rate because the first one to exit  gets the full brunt. Exchange rate appreciation becomes much more difficult to go out.

"You need some sort of coordination or cooperation for everybody to slowly move out but I am not sure we have the kinds of frameworks to do that right now.

"The second spillover is more of a idea spillover, which just the emerging markets have started adopting, the orthodoxy, which helped us survive some of the more dramatic effects of the crisis, the industrial countries have stated debating all the orthodoxy.

"So there used to be, for example IMF was all about fiscal consolidation and the fiscal rectitude, even that last bastion has given way. For us in emerging markets even to talk about fiscal rectitude becomes very hard because immediately they point to IMF that even the IMF doesn't talk about fiscal rectitude.

"If you are an emerging market, a small boat in a turbulent ocean of policy and environment emerging from elsewhere, what do you do? You want us to be more orthodox, but you want us to be more orthodox in an environment where orthodoxy is being thrown out of the window.

"So it does become much more difficult to talk about labour market flexibility, low fiscal deficit, low inflation, all those good things in such an environment," he said.

He further said the industrial countries had the benefit of being where they were of showing the way to prosperity and growth. On the other hand, all emerging markets had the debate on how they were unique and the laws of economics do not apply to them, but they were also looking to "pick up the same path and bring down inflation, bring down other things and get to the glorious days when they themselves become rich".

"But now we have two strikes against that path. One is there was a big crisis and how much that path was responsible for the crisis. Was inflation targeting the reason, why we had that massive crisis, that debate is going on.

"And second, that the industrial countries are themselves debating the orthodoxy, which then means even they don't believe in that. So therefore what do we do? For somebody who believes entirely in what Jacob has been talking about, life is very difficult in an emerging market," he said.