The man who predicted the financial crisis has some advice for the world’s central banks

This is serious.
This is serious.
Image: Reuters/Brendan McDermid
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Before Raghuram Rajan became the governor of the Reserve Bank of India, he was the former chief economist of the International Monetary Fund (IMF) who famously predicted the source of the global financial meltdown in 2005. It’s another matter that few listened.

Now, India’s central banker has some advice for his counterparts elsewhere in the world: Aggressive and competitive monetary policies are a risk.

In a speech at the Economic Club of New York on May 19, Rajan argued that the “spectre of deflation” is spurring major central banks around the world into a dangerous struggle for stronger domestic growth. This struggle, he added, is risky for financial markets and also ignores the needs of developing nations.

“I fear that in a world with weak aggregate demand, we may be engaged in a risky competition for a greater share of it,” Rajan said. ”We are thereby also creating financial sector risks for when unconventional policies end.”

In recent years, central banks in major economies have held interest rates to near zero and embarked on asset-purchasing programmes in a bid to lower the cost of borrowing. But now, with the end of the bond-buying programme, and a possibility of an interest rate hike in the US, equity markets—especially in India—have been extremely volatile.

Rajan also made a case for better coordination among central banks on the monetary policy. “It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action,” he said. “We are being pushed towards competitive monetary easing.”

“We need much clearer rules of the game on what’s allowed and what’s not allowed,” Rajan added.

Modi’s image

In a question-and-answer session after his speech, Rajan also spoke on the performance of Indian prime minister Narendra Modi’s first year in power.

The new Indian government, he said, came in with huge expectations, which were probably unrealistic. The perception of Modi as some sort of  “Ronald Reagan on a white horse” coming to slay anti-market forces was “probably not appropriate,” Rajan explained.

The Modi government, he added, is sensitive towards investors and has taken steps to create an environment for investment, although in recent weeks the issue over unpaid minimum alternate tax on foreign investors has flared up. The total tax bill for international funds and banks could be as much as $8 billion, according to estimates.