Central banks ‘fall guys’ for populist mistakes, says Rajan

Raghuram Rajan.

Raghuram Rajan.  

‘Easing monetary policy may encourage riskier play by govt.’

Central banks are ‘fall guys’ and required to ease monetary policy to compensate for populist mistakes made by governments, according to former Reserve Bank of India (RBI) Governor Raghuram Rajan.

“A central bank’s mandate requires it to ease monetary policy when growth is flagging, even when the government’s own policies are the problem,” Mr. Rajan wrote in an article, without specifically mentioning India.

“Though the central bank is still autonomous, it effectively becomes a dependent follower.” In such cases, he added, such actions by the central banks could even encourage the government to implement riskier policies on the assumption that the former would bail out the economy whenever needed.

“Worse, populist leaders may mistakenly believe the central bank can do more to rescue the economy from their policy mistakes than it actually can deliver,” Mr. Rajan wrote.

“Such misunderstandings could be deeply problematic for the economy.”

‘Public attack’

The former RBI Governor added that central bankers “are not immune to public attack”, since they know that they are being set up to take the fall in case the economy falters.

“In the past, the cost would have been higher inflation over the medium term; today, it is more likely that the cost will be more future financial instability,” Mr. Rajan said.

“This possibility, of course, will tend to depress market interest rates further rather than elevating them.”

In order to combat this, Mr. Rajan added, central bankers have to explain to the public what their role is and why it is more than “simply moving interest rates up or down on a whim”.

“Shattering the mystique surrounding central banking could open it to attack in the short run, but will pay off in the long run,” he said. “The sooner the public understands that central bankers are ordinary people doing a difficult job with limited tools under trying circumstances, the less it will expect monetary policy magically to correct elected politicians’ errors.”

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Printable version | Jun 5, 2020 10:08:44 AM |

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