Rajan for global pact to help deal with monetary policy problems

RBI Governor Raghuram Rajan on Monday said the world is facing “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 that 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 added. The Bretton Woods conference led to the setting up of IMF, World Bank. He said 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.

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.