Raghuram Rajan hits back at critics: “You can fool all of the people only some of the time”
Raghuram Rajan will return to academia once his term as governor of India’s central bank ends in September.
Although the precise reasons for Rajan’s exit from the Reserve Bank of India (RBI) are unclear, there has been friction between him and the Narendra Modi government over interest rates. The governor preferred higher rates so that inflation could be kept in check, while the government pushed for lower rates to stimulate growth.
In a speech—his first public appearance after he announced his exit—on June 20 in Mumbai, Rajan hit back at his critics and defended his actions. His explanation is pretty straightforward: low interest rates aren’t sustainable for economic growth in the long run.
There is indeed a short run trade-off between inflation and growth. In layman’s terms, if the central bank cuts the interest rate by 100 basis points today, and banks pass it on, then demand will pick up and we could get stronger growth for a while, especially if economic players are surprised. The stock market may shoot up for a few days. But you can fool all of the people only some of the time. If the economy is producing at potential, we would quickly see shortages and a sharp rise in inflation. People will also start expecting the central bank to disregard inflation (that is, be hopelessly dovish according to the bird analogies that abound) and embed high inflationary expectations into their decisions, including their demand for higher wages.
The case for low rates
Rajan explained the rationale behind the RBI’s hawkish stance on interest rates. Indicating that he was right in not cutting rates extensively, he said that the central bank doesn’t focus only on inflation “to the exclusion of growth.”
The Real Style ------ NP2016
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