Reserve Bank of India Governor Raghuram Rajan, on Tuesday, called for regulators to exert greater caution when faced with the potentially inflammatory mix of asset price inflation and easy credit.
Addressing the Bank of Italy on lessons learned after the economic crisis of 2007 to 2009, Dr. Rajan said the key to getting the benefits of financial access was to “always be conservative, taking away the punch (bowl) when the party gets going.’’
Looking back at the Great Depression in the United States in the 1930s in an examination of speculative bubbles and their effect on monetary policy, Dr. Rajan said it was clear that greater credit availability tended to make the economy sensitive to shocks.
The rise in asset prices and build-up in associated leverage in the U.S. in the lead-up to the bust were so substantial that there were significantly more bank failures in areas with greater credit access, he said. “What does this mean for prudential risk management? It means it may make sense to lean into the wind,’’ he said, using a term taken to mean the tightening of monetary conditions when an economy is strong but before evident signs of overheating appear.
“Even if the rise in credit and asset prices is driven by fundamentals, be wary. Be conservative,’’ he added, calling on “supervisors to be constantly on the look out for credit price increase and asset increase.’’
Dr. Rajan said both emerging markets and developed countries had been urged time and again to tighten their budgets, but “despite this advice, they don’t tighten them enough.’’— AFP