Former IMF Chief Economist, Now India’s Central Bank Governor Rajan Takes Shot at Bernanke’s Destabilizing Policies

As Bernanke is about to take leave of office, attacks on his policies are becoming louder, thanks to financial markets turmoil resulting from the Bernanke/Geithner approach to the crisis: do whatever it takes to restore as much of status quo ante as possible. The problem, of course, is that status quo ante is what got us in this mess in the first place.

Another element of the resolution of the crisis that is simply not acknowledged in the American or European media all that much is the degree to which emerging economies engaged in stimulus programs which helped keep the global boat afloat, while advanced economies fixated on saving the banks and did far too little in the way of shoring up demand.

India central bank governor Raghuram Rajan took to Bloomberg to criticize the Fed for its failure to coordinate policies with the rest of the world. And Rajan can’t be dismissed as a partisan defending his country’s policies. Rajan is a Serious Economist, former IMF chief economist, and best known in popular circles for presenting a badly-received paper at Greenspan’s last Jackson Hole session that said that financial innovation was making the world riskier and could well cause a full blown financial crisis. And he assumed office only last September, so he’s also not defending policies he implemented.

Rajan is blunt by the standards of official discourse. I suggest you watch the interview starting at 9:10.

Some of his key points:

Emerging markets were hurt both by the easy money which flowed into their economies and made it easier to forget about the necessary reforms, the necessary fiscal actions that had to be taken, on top of the fact that emerging markets tried to support global growth by huge fiscal and monetary stimulus across the emerging markets. This easy money, which overlaid already strong fiscal stimulus from these countries. The reason emerging markets were unhappy with this easy money is “This is going to make it difficult for us to do the necessary adjustment.” And the industrial countries at this point said, “What do you want us to do, we have weak economies, we’ll do whatever we need to do. Let the money flow.”

Now when they are withdrawing that money, they are saying, “You complained when it went in. Why should you complain when it went out?” And we complain for the same reason when it goes out as when it goes in: it distorts our economies, and the money coming in made it more difficult for us to do the adjustment we need for the sustainable growth and to prepare for the money going out

International monetary cooperation has broken down. Industrial countries have to play a part in restoring that, and they can’t at this point wash their hands off and say we’ll do what we need to and you do the adjustment. ….Fortunately the IMF has stopped giving this as its mantra, but you hear from the industrial countries: We’ll do what we have to do, the markets will adjust and you can decide what you want to do…. We need better cooperation and unfortunately that’s not been forthcoming so far.

Narrowly, Rajan is correct, but the underlying problem is much bigger and most orthodox economists are unwilling to confront it because it conflicts with their free markets religion. Carmen Reinhart and Ken Rogoff, in an analysis that got much less attention that their work on debt levels and growth, looked at 800 years of history of crises and found a strong correlation between the level of international capital flows and the frequency and severity of financial crises. That’s implicit in his discussion of the impact of hot money flowing in and out. The Reinhart/Rogoff finding was confirmed by a 2010 paper by Claudio Borio and Piti Disyatat of the BIS that argued that what drives financial crises is not net capital flows (“global imbalances”) but gross capital flows (too much financial “elasticity” as they called it, or what most of us would describe as too much speculation). But Rajan may in fact be referring to remedies like capital controls when he says, basically, that the industrial economies may not like the remedies that emerging economies implement.

Advanced economies may choose to pretend, as the central bankers that Rajan calls out do, that the emerging markets live in a separate universe and their pains are of little importance to advanced economies. That’s true only if distress stays at a low level. As Scott points out by e-mail, the Asian crisis took place when the emerging market share of GDP was in the low 30%. Lehman nearly failed then (although it was a less important firm) and had LTCM not been rescued, its collapse might well have kicked off a crisis. Emerging markets now represent over 50% of global GDP, advanced economies are much weaker than in the 1990s, with more fragile financial institutions and much frothier asset valuations. And you also have the potential for real economy disruption too: global supply chains are much longer, and economic stress can quickly morph into political dislocation. In 1997, the rapid fall of currencies led to food-related riots in Thailand and Indonesia. Energy and agricultural commodity prices are higher now than then, so in many countries, a mere moderate decline in the currency will put a large chunk of the populace in serious distress.

Paul Krugman, without mentioning Rajan, took a broadly similar line in his new column, that advanced economies were making their emerging brethren bear the costs of the failure to clean house (notice how regularly that is projected on to the emerging economies). Key points:

You may or may not have heard that there’s a big debate among economists about whether we face “secular stagnation.” What’s that? Well, one way to describe it is as a situation in which the amount people want to save exceeds the volume of investments worth making.

When that’s true, you have one of two outcomes. If investors are being cautious and prudent, we are collectively, in effect, trying to spend less than our income, and since my spending is your income and your spending is my income, the result is a persistent slump.

Alternatively, flailing investors — frustrated by low returns and desperate for yield — can delude themselves, pouring money into ill-conceived projects, be they subprime lending or capital flows to emerging markets. This can boost the economy for a while, but eventually investors face reality, the money dries up and pain follows.

If this is a good description of our situation, and I believe it is, we now have a world economy destined to seesaw between bubbles and depression.

The larger point is that Turkey isn’t really the problem; neither are South Africa, Russia, Hungary, India, and whoever else is getting hit right now. The real problem is that the world’s wealthy economies — the United States, the euro area, and smaller players, too — have failed to deal with their own underlying weaknesses. Most obviously, faced with a private sector that wants to save too much and invest too little, we have pursued austerity policies that deepen the forces of depression. Worse yet, all indications are that, by allowing unemployment to fester, we’re depressing our long-run as well as short-run growth prospects, which will depress private investment even more.

Oh, and much of Europe is already at risk of a Japanese-style deflationary trap. An emerging-markets crisis could, all too plausibly, turn that risk into reality.

As readers know, NC is not taken with the “secular stagnation” thesis; it’s based on what John Quiggin calls zombie economics, ideas that have been debunked but still soldier on (see here, here, and here). Notice how it leads Krugman to characterize the problem (following Bernanke) as too much savings, as opposed to too little investment. As we’ve written repeatedly, large businesses, which do the bulk of investment spending, have become so fixated on short-term earning that they underinvest. That behavior was evident before the crisis, in 2006. It’s been confirmed by Andrew Haldane of the Bank of England via ascertaining that corporations use too high a required rate of return when evaluating investments, which leads them to invest less than is optimal for them or the economy as a whole (their executives’ pay packages are another matter).

But independent of Krugman’s assessment of why we are in the flagging growth mess we are in now, his description of responses is generally valid. But it’s not “either/or”. The resolution of the crisis has made the top wealthy even richer, while leaving everyone else a smidge worse off. And how much capital chases opportunities is a function not just of gross savings but how much leverage on leverage the financial system creates. As we discussed long-form in ECONNED, the shadow banking system, particularly CDOs, created a tremendous amount of gearing and was the main cause of the “wall of liquidity” of early 2007.

As a result of only superficially addressing the causes of the crisis just past, we are guaranteed to have more, likely even bigger ones, and were hardly alone in espousing that view. Whether this crisis can be contained remains to be seen, but Rajan’s assessment that the major central banks are in “every man for himself” mode does not bode well for dampening down the dislocation.

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  1. Ben Johannson

    Frankly, we haven’t had close coordination since the boom days of the Bretton-Woods system. In fact the very reason the gold window worked so well was due to how smartly the world was working together in the wake of WWII, similar to the relatively smooth function of the pre-WWI gold standard in trade.

    Since the 1970’s the paradigm has been one of mostly-disguised war between countries competing for artificially limited demand, oligarchs competing for superior social position and interest groups bludgeoning each other for a meal ticket. Failure to cooperate and coordinate globally is a major source of our continuing economic instability and shredded social cohesion.

    1. digi_owl

      Adam Curtis’ The Trap comes to mind. It demonstrates how for decades the western world have been pushed towards praising sociopathic and narcissistic behavior under the banner of “personal freedom”.

    2. The Dork of Cork

      I completely disagree,
      Monetary cooperation between former nations is the root cause of our problems.
      How can you say otherwise ?
      We have seen massive capital and subsequent labour moves so as to maximise production in Europe and elsewhere.
      However the real costs are forced on the resident populations of these former nations.

      So we have massive production and reduced demand as a result of the economic externalties of global trade based on paying off debt and not real comparative advantage.

      We are living in a 1914 like glut of capital goods overproduction which is causing artifical scarcity on basic goods.

      Banking unions be it continental or worldwide is always bad news for most people (real bad news)
      As it destroys all local exchange.
      That is what they are designed to do.
      Its the basic and now old economics of village burning.

      1. Moneta

        The first phase was money printing… every body was on board.

        Now, many countries will play the export card… that’s when we will see the lack of cooperation.

      2. Calgacus

        Don’t often agree with you, Dork of Cork, but you are mainly on the mark here. There is NO “case for concerted action”. People should read Keynes’s essay “National Self-Sufficiency” for one. The main “international cooperation” has generally been international cooperation to make sure international banksters and currency speculators don’t go broke, or to saddle their bad debts on poor people, in order to pay other rich, reckless speculators. The problem is artificial demand limitation – in particular strangling the effective demand of people who uhh do all the work of the world. Take care of full employment – return unemployment to its natural rate of zero – and everything else takes care of itself.

        Given full employment, “Free markets” are the main helpful international cooperation and coordination, and they aren’t even that important. Bring on the “war” of non-cooperation of floating currencies. It’s a good thing. Bretton Woods could work because every nation decided to have full employment, not the other way around.

    3. F. Beard

      Ha,ha! So even a gold standard (fascist) is to be preferred over ethical money creation?

      Well, like the proverb says:
      Like a dog that returns to its vomit is a fool who repeats his folly. Proverbs 26:11

    4. Ben Johannson

      With respect, a lot of comments from people who don’t seem to be responding to what I actually wrote. I stated there is no longer close cooperation regarding trade in ensuring a smoothly functioning system. Trade balances were sought successfully by central banks and governments in the past but haven’t been for forty years. Other commentors have ignored this in favor of attacking close cooperation in capital movement. One is not the other.

      F. Beard: you still don’t understand the difference between gold domestically and gold internationally. They aren’t the same thing, nor did anyone but you talk about gold being preferred. I’m beginning to think you’re a closet goldbug.

      1. Calgacus

        Trade balances were sought successfully by central banks and governments in the past but haven’t been for forty years.

        The point is – why is this a good or important thing? Conceivably it could be nice, but it is minor. Bretton Woods could be successful that way because each individual nation preyed on its own people less. And the minor benefits are used to cloak highly destructive “cooperation”.

        Failure to cooperate and coordinate globally is a major source of our continuing economic instability and shredded social cohesion.

        No, it isn’t. Successful global cooperation and coordination of looters playing everyone else for suckers is. No cooperation at all would be much better. In addition to Keynes essay, I recommend, as always the chapters on international trade in Lerner’s Economics of Employment.

  2. Moneta

    There are essentially 2 very visible groups that made easy money over the last few decades: those in the fire economy and exporters. Those are the ones with the money and the power.

    Here in Canada, with our debt-to-GDP ratio back at close to 100%, FI is on hold, RE is floundering so the only game left in town is exports. We are lucky because our dollar was at parity before it dropped like a rock over the last few months so it gave us some ground and because we have oil… . But many other countries are not so lucky.

    Powerful people in all countries love printing and that was the game for the last 5 years. All rich people can stomach higher asset values. And the printing kept exports going. But if the US tries to force the great trade rebalancing that should be happening in theory, countries with powerful export magnates will push back. That’s when the sparks will appear and G20 meetings will lead to nowhere.

  3. arby

    He ignores the question at the 9 minute Mark to make his own point to central bankers of developed countries who apparently told him that he needs to be a good boy and deal with the mess. He labels the flow in and out of hot money as an ‘attack’ and then pointedly says “They might not like the kinds of adjustments we will be forced to do down the line.”

    Thank you for posting this.

  4. Moneta

    Here in Canada, during the last few years where the CAD was at par, Carney our central banker, kept on telling our industry to take advantage of our strong currency to invest and “retool”.

    I doubt Canada retooled because of structural and demographic issues. Many of the firms are owned by entrepreneurs who are nearing retirement. Due to monetary policies which promote short-termism, easy money has permitted them to sell off their companies to private equity funds at top dollars.

    One of my friends’ father sold his co. to such a PE firm at top dollars just before the crisis and bought it back after the crisis for peanuts using cheap financing. He is much richer and has not bothered to retool.

    When talking about this to an acquaintance, she chuckled and said that she had a same story and we probably knew the same person. It wasn’t, it was another owner who used the exact same strategy.

    There is truly a dearth of investment. It’s all about paper gains.

  5. James Levy

    You wonder how much of this is also generational. The two World Wars and the failure to cooperate and coordinate during the Great Depression taught a generation of politicos, bureaucrats, corporate titans, and military men how to work together both internally and internationally. Those people are now dead or in their 90s. The generation that followed them grew up, here in America, rich and arrogant (the Dubya generation of oligarchs). In Europe they grew up obsequious (the British) or distrustful (the Continent). None of that boded well for true cooperation. And passing off the costs of hegemony to the US was too easy and amenable to all concerned not to happen. So now, when we need to work together, and what is more get the BRICs on board, there is no constituency and no trained cadre to make that cooperation happen.

  6. Middle Seaman

    Two points are not in dispute: The developed countries are not doing well and in the last 5 years the improvements in the economy weren’t substantial. The developing world is, by and large, in shadowing the failures of the developed world. Furthermore, banks and the rich have been the beneficiaries of enormous larges from governments. Developed countries instituted austerity policies with disastrous results and, yet, are still sticking to that.

    Some of us read NC and Krugman daily. Despite natural repetition, we view the two sources as reliable, honest and factual. I see no reason to prefer “Zombie language” from other sources with a lesser track record.

    Why should anyone be surprised that the developed world and the developing one aren’t even trying to collaborate or coordinate. In the US, the president, the Fed and congress seem to have a single goal: enrich the rich.

  7. Jackrabbit

    Middle Seaman says:

    “Some of us . . . view the two sources [NC and Krugman] as reliable, honest and factual. . . . In the US, the president, the Fed and congress seem to have a single goal: enrich the rich.”

    I am at a loss as to why Paul Krugman gets so much respect as what he has to say is soooo predictable (click link if you don’t aleady know).

    He is a an Obama partisan that dresses up his views as independent. Many adore him for his obvious – and all-too-easy – attacks on the crazy right. But the ‘street cred’ he gains by doing so is used to undermine progressives and shape public opinion for the Obama Administration.

    Middle Seaman is not alone in his view. Unfortunately, Krugman’s credibility is enhanced by the many economists and bloggers that refer to him without noting his pro-Administration viewpoint). Why not add a note to such mentions like: “Obama partisan Krugman” or “Administration-friendly pundit Krugman”? Furthermore, it seems inconsistent to critize Krugman on so many important issues yet include him in the blogroll. This creates cognitive dissonance for readers. Consider Paul Krugman’s support for:

    Obamacare: a give away to insurance companies, non-reform of healhcare, and a general failure that is likely to be a vote-getter for Republicans this fall;
    Blowing bubbles: a perverse policy choice shared with his friend Summers – ’nuff said;
    TPP: willfully ignoring the ‘hit’ to democracy;
    Obama’s faux solution for inequality: increasing the minimum wage is not the answer, it is just a start.

    (Note: Not an exhaustive list of Krugman FAIL)

    Lastly, if Paul Krugman is so central to economics and truly considers himself the “conscience of a liberal”, then how has he used that exhalted position? To what extent has he pushed for ethical reforms for economists? (my perception is that reform has been weak at best). He complains about inequality, but to what extent has he drove that home by denouncing tax advantages like ‘carried interest’ – why hasn’t he taken Obama to task for not closing this as he promised? What about TBTF and corporate governance? Why is Simon Johnson the leader on TBTF?

      1. James Levy

        You hit the nail on the head. Nobody wants to be thrown out of the in crowd. Krugman has a great gig but the same drive that puts people in big jobs at Princeton pushes them on to want more. And the “more” is always access to the rich and powerful. That access is limited to those who will stick to the established narratives and not go off the reservation. In a variation of the old line from Upton Sinclair, it’s tough for an academic to think or talk about things if thinking and talking about them will get them expelled from the inner sanctums and the Op-Ed page of the NY Times. It’s just too big an ego boost (and too lucrative) NOT to tell the truth. Another paraphrase: How are you gonna keep in down on the campus, after they’ve seen DC?

        1. j gibbs

          There’s also something else. Any economist savvy enough to understand what is wrong is probably also savvy enough to know that the forces in charge aren’t about to relinquish the benefits of being in charge. In our system, them that have get. They like it like that.

      1. Jackrabbit

        I’m not sure what you’re getting at. There are many ways to take this.

        Obama = sell out President
        MLK = courageous man of principle
        Krugman = crony/acolyte/supporter of sell out President
        ? = associate of courageous man of principle (take your pick)

        1. MikeNY

          You understood the crux of it…

          MLK was truth. Obama is politics, and ‘the art of the possible’. The two are not normally close associates. Who, in your opinion, is the analogue to MLK in the economic sphere, today?

    1. Jackrabbit

      Well, replies to my comment are just excuses that are reflective of the culture that we bemoan on NC day after day: we can’t blame Krugs for looking out for his own interest! What sort of moralizing SOB would ask that a public figure be held to a higher standard?

      There are two problems here:
      1) Disingenuous public figures that fool people into thinking that they know more/better and have their best interests at heart.
      2) Those that know about (1) and look the other way.

      1. Moneta

        A few years ago when I opened my mouth and sacrificed my career to speak the truth, I asked my husband: “Why won’t people stand up for their beliefs.”

        He said flat out: “Perhaps their survival instinct is stronger than yours.”

        Until the day we manage to create a system that protects us from our human selves, we will see the same phenomenon over and over.

        And BTW, I am not excusing Krugman, I am explaining his behavior. You asked why Krugman was not denouncing the “crimes” and I said it was probably due to a very strong human urge of not getting ostracised. I never condoned his actions.

        BTW, once you are ostracised, it is very hard to accomplish anything good… so Krugman’s tactic might be the most efficient to actually get anything done over time.

        1. Jackrabbit

          Well I can’t know what is really in Krugman’s heart (of course) but all I see is excuses for him. And such excuses are part and parcel of the crony game, where every crony is sure to get a few others speaking up for them. “Don’t blame the player, blame the game!” they cry.

          Krugman lends his voice to Obama neo-lib, crony-friendly policies. He doesn’t have to do that. Is he doing good around the edges? That’s very doubtful when you see the full-throated cheerleading and effusive praise for people like Summers.

          Get real people.

          1. Jackrabbit

            Just to clarify. I’m not saying that anyone here is a crony or crony-sympathizer. I think there are many people – probably most – that see how the system works and don’t want to rock the boat or take the risk to their career. And others that psychologically or otherwise have bought into the system so thoroughly that they can’t imagine that ‘good people’ like Krugman might have an agenda (in essence they suffer from cognitive capture).

            Please remember that my initial comment was directed at 1) Middle Seaman, who is critical of Obama but praises Krugman, and 2) bloggers and other that pretend that Krugman’s views are neutral/independent.

  8. Chauncey Gardiner

    Since early September 2008, the Bernanke Fed has increased the size of its balance sheet under various QE-ZIRP programs to over $4.1 trillion from $900 billion at inception, while suppressing real interest rates to negative 2 percent in an effort to force those with capital into equities and long term bonds, fattening the banks’ Net Interest Margins, and providing rocket fuel to the big trading banks for global speculation under what is termed as “the carry trade”. In terms of meeting its primary albeit unstated objectives, the Fed’s policy during this period can only be characterized as wildly successful.

    It’s just that there are these awkward moments when those innocent parties who are suffering collateral damage as a result of these policies protest vocally and articulately.

    Thank you for posting this interview. Although I remain undecided whether the Bank of India is a member of the parasitic global cartel, I am leaning toward the view that it is not.

  9. Eric L. Prentis

    Businesses Follow Demand
    International corporations are cash rich, after championing weak trade unions, aggressive cost cutting displacing workers, slowing wage growth and reducing capital investment. However, these same companies are not hurrying to invest their large amassed cash reserves, because they do not know which products or services to invest in.

    The Fed’s Zero Interest Rate Policy (ZIRP) is taking about $425 billion dollars a year of interest income out of consumers’ pockets (Duy, January 29, 2012). This is ironic, because when interest rates are high during the mid-1980s, the U.S. economy is strong. Restraint of economic growth is not because of high interest rates, but hinges on profitable productive opportunities for businesses to expand operations, based on growing consumer demand.

    Because U.S. consumers have reduced disposable income to spend, businesses will not make capital investments if they observe declining demand for their goods and services. Even technology led products are risky and prone to economic failure. Rather than investing, large corporations are simply increasing stock dividend payments and buying back their shares.

    The major economic problem is the U.S. is lacking final consumer demand, because of ZIRP and an over-indebted society. Increased government demand is not real demand, decided on by consumers. Businesses, rightly so, do not trust this fabricated government demand, since it can change on a politician’s whim.

    This is an excerpt from:
    Prentis, Eric L. (2013) Competitive Market Economies: Self-Regulating Markets vs. Economic Stability, and the Paradox of Change. “Journal of Business, Economics & Finance.”

  10. H. Alexander Ivey

    “(their executives’ pay packages are another matter).”

    Umm, actually, I think pay packages are exactly the matter. Companies are not people, the people in the upper management are “the company”. And these people make company decisions based on their pay packages, not on what-is-good-for-the-country or Mom or apple pie.

  11. Lune

    So when will developing economies finally throw off the Washington consensus and [re-]implement capital controls? It makes so much sense economically for them that it’s unfathomable why they haven’t done so yet (China being the main exception). Until you consider the politics…

    Emerging economies have 1%’ers whose interests are more aligned with the global 1%’ers than with their own nation’s 99%. The average poor farmer or worker bee in India isn’t really impacted by capital controls. 99% of his lifetime’s financial transactions are in rupees. But all those financial flows do benefit India’s 1% who can siphon off rents managing those flows and also direct those flows in a way that’s beneficial to their bottom line. So despite Rajan’s threats, I doubt India’s political class will have the guts to carry out their implied threat. After all, with capital controls, how will India’s robber barons convert their black money to USD in Swiss bank accounts?

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