ECONOMYNEXT – Monetary policy cannot solve problems of long term growth and ‘aggressive’ money printing to reverse deflation may have "great costs", Reserve Bank of India Governor Raghuram Rajan warned.
Monetary policy cannot substitute for structural reforms and one reason for slow growth in recent years was also an overhang of debt, he said.
"But as central bankers flirt with ever more unconventional policies, it is worth asking if these policies really move the economy towards the desired objective," Rajan told an economic forum in New Delhi, Advancing Asia hosted by the International Monetary Fund and India.
"Monetary policy works through the public’s expectations. If ever more aggressive policy convinces the public that calamity is around the corner, it may tempt large segments to save rather than spend. T
"The effect is magnified if there is a sense that the consequences of today’s policies (distorted asset prices, high government debt, high private debt etc.) will have to be reversed in the future at great cost to the system."
He questioned whether Japan had really suffered from deflation as often claimed. If adjusted for the falling population Japan had adjusted quite well, he said.
Gently falling prices help not only the wage earners but also old people, analysts have said. Japanese firms have invested in countries like Vietnam as its exchange rate got stronger over the past two decades providing jobs of millions of peoples.
"What is the biggest problem with deflation?" Rajan questioned. "It is debt".
The solution was to deal with the debt, not to create new inflation he said.
Many developed nations had to undertake structural reforms to put growth to higher levels, but it was politically unpalatable because of special interests that benefitted from them at now, he said.
"While the jury is still out on the effects of unconventional monetary policy on the domestic economy, it seems fair to say that the benefits seem to be diminishing after years of effort, and the costs increasing," Rajan said.
"Also, if structural impediments are the primary cause of slow growth, one could ask if unconventional monetary policy, by giving the public the impression that something is being done, actually takes the pressure off politicians to undertake the required policy actions – by stating monetary policy is the only game in town, central bankers make it the only game in town."
He said stimulus in one country tended to increase demand and draw imports from other countries, reducing their domestic effects but could also send capital out of the country chasing yields elsewhere as domestic rates fell, creating problems for other countries.
Rajan repeated calls for an international system and a dialog or research to examine the possibility of key central banks being required to consider the effects of their action on the rest the world.