Economist Raghuram Rajan on Monetary Policy, Trade and Communities

Published on03 MAR 2020

The article below is from our BRIEFINGS newsletter of 03 March 2020

Raghuram Rajan, former chief economist for the International Monetary Fund (IMF) and India’s former central banker, shared his views on monetary policies, the risk of global supply chains and the importance of communities in a wide-ranging conversation with Goldman Sachs’ Katie Koch, co-head of Goldman Sachs Asset Management’s (GSAM) Fundamental Equity business, at a GSAM Forum event in New York. What follows are excerpts from their conversation. 

Katie Koch: Let’s start off with the global perspective: Where do you think we are in the economic cycle and how much further you think we have to go in the US? 

Raghuram Rajan: What is interesting is that we have a global economy which continues to be chugging along at a mediocre pace—neither too hot nor too cold—which doesn’t have enough momentum to take off but is not so bad that it plunges into a recession either. And if—and this is a big if—coronavirus is contained, there’s no reason why we won’t see this continue for some time. Of course, monetary tightening is one of the factors that could disrupt this process, but central banks, including the Federal Reserve, have indicated that further tightening is off the table for now. 

Katie Koch: If the central banks are preferring to run economies “hot,” why have we seen so little inflation—despite relatively tight labor markets? 

Raghuram Rajan: If you talk to business owners today, they will tell you they can’t find people to hire even though they’re willing to pay more. One possibility—which we’ve seen in Japan—is that with an aging population, you’ll have older employees retiring and younger people moving in. So while companies may be paying the new people higher wages, the average wage bill won’t be increasing as much given that the experienced, more expensive, employees have moved on. The other comparable period where we had low inflation and tight labor markets was in the mid-1960s. At the time, we had similar conditions before inflation suddenly took off. Inflation will reassert itself at some point, but I think we have some room. 

Katie Koch: Given your experiences at the IMF and at India’s central bank, what do you make of the rising populism around the world and whether that could be a potential constraint on growth and trade?

Raghuram Rajan: If you notice where the protests are taking place, they’re in the areas where the populations haven’t benefited as much from globalization, technology improvements and trade. That’s creating internal frictions and we’re seeing the type of policy paralysis that we have in Washington today being replicated across other countries. And when you have internal policy paralysis, you don’t have strong growth. At the same time, we’re seeing renewed focus on the efficiency and risk exposures of global supply chains. So when you have a problem in China—such as coronavirus disrupting global supply chains—you’re going to see a pulling back on trade and potentially some re-shoring of manufacturing jobs. 

Katie Koch: On monetary policy, how do you feel about the credibility of central banks and their ability to get us out of the next recession?

Raghuram Rajan: A lot of monetary policy works through changing people’s expectations in the direction that you want. And in the real world, one of the hardest things to do is to change people’s expectations. My sense is that we don’t have a strong sense of how to do that. Consider Japan, which is the first country to deal seriously with the problem of an aging population. The country has been at the forefront of inventing new monetary policy tools to boost growth, but these tools have had a very modest impact. Although central banks still have some room —by restarting quantitative easing, for example—I don’t think there’s a huge amount.

Katie Koch: Let’s pivot to India. Prime Minister Modi has committed to reaching a $5 trillion GDP by 2024. If we were to extrapolate that from where we are now, that assumes India’s economic growth would have to nearly double in real terms from where we are today. How will India get there?   

Raghuram Rajan: We’re seeing a bit of a cyclical pickup in India but I doubt we’re going to get anywhere near the growth rates that are required without serious reform. And unfortunately, we’re just tinkering at the margin. The most serious problem right now is in the financial sector, which needs to be cleaned up so that it has a chance to move higher. But there was very little discussion in India’s recently released budget of what needs to be done. Budgets are an occasion where India’s government can provide its vision for the economy and to show a sense of urgency. But I didn’t really see that vision and urgency reflected in the latest release. 

Katie Koch: You’ve recently published a book called The Third Pillar which talks about the role of the market and state in modern society, and why we need to include the “third pillar” of community into that discussion. Why does community matter so much?

Raghuram Rajan: Throughout much of the 20th century, the debate was about markets versus government—some people wanted more government intervention and some people wanted less. But that discussion misses out on the tremendous role the community played in preparing people for the markets. You’re essentially born into a family that teaches you values. You go to a school where you’re surrounded by friends and neighbors. And what we increasingly see is that where you’re born and where you grow up makes a huge difference in your lifetime earnings. And I think the missing piece is that we need to fix communities at the local level. Unless you have a healthier community—with a greater sense of purpose—job activity disappears, resulting a breakdown of the social fabric. This is a pattern that is replicating itself now in predominantly white communities where the largest employer leaves town. Jobs are lost, marriages fall apart, teenage pregnancies increase and drugs and alcohol move in. The opioid epidemic is, in a sense, a reflection of this hopelessness.

More broadly, from a global perspective, you’ve seen power move from the local communities, to the national and then to the global levels. If you think about Brexit’s rallying cry it was to take back control, not just from Brussels to London, but from London to Manchester and then from Manchester to the local governments. That process will start to reassert itself. In order to preserve the globalization of trade, we should look to reverse the globalization of governance and to bring it back to communities. Because without people feeling a sense of control, they’re not going to support the globalization of trade.





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