The RBI said called for guidelines to curb central banks globally adopting unconventional monetary policies and seeking exchange rate or financial market interventions to restore growth which may have large adverse spillover effects on others, which then could resort to aggressive policies to gain even small positive domestic effects.
“Perhaps instead, countries could agree to guidelines for responsible behavior that would improve collective outcomes,” Reserve Bank of India Governor Raghuram Rajan and the bank’s specialist advisor Prachi Mishra jointly wrote in a series working paper titled “Rules of the Monetary Game.”
Otherwise consequently, the world may embark on a sub-optimal collective path, the duo said, ahead of the RBI’s first monetary policy for the next fiscal due next Tuesday.
“The bottom line is that simply because a policy is called monetary, unconventional or otherwise, it may not be beneficial on net for the world. That all monetary policies have external spillovers does not mean that they are all justified. What matters is the relative magnitude of demand creating versus demand switching effects, and the magnitude of other net financial sector spillovers, that is, the net spillovers,” the paper said.
“Easy monetary conditions in advanced economies can lead to capital inflows, exchange rate appreciation, rapid credit growth, and asset price bubbles in emerging markets (EMs). On the other hand, monetary normalisation, or a rise in interest rates in advanced economies can cause capital outflows and exchange rate depreciation in the EMs,” it added.
The paper warns that dangers from applying prevalent global economic models for policy purposes could perhaps be significant.
“For example, the choice of scenarios that are played up prominently in policy documents could be tinged by ideology,” it said and suggests that towards creating a new global model, countries should engage proceed with eminent academics, there should be international seminars and discussions on the subject, and the International Monetary Fund should be involved.
“There can be no more important issue to understand and discuss than the international spillovers of domestic policies. Such a discussion need not take place in an environment of finger pointing and defensiveness, but as an attempt to understand what can be reasonable, and not overly intrusive, rules of conduct,” it added.
In a commentary posted on the website of Project Syndicate last week, Rajan said that the world needs a new international agreement on the lines of Bretton Woods that created the current multilateral financial system, to prevent central banks from adopting policies that could hurt other economies.
He said that central banks in developed countries find various ways to justify their policies, without acknowledging that the exchange rate may be the primary channel of transmission.
He said the world is facing an increasingly dangerous situation and both advanced and emerging economies need to grow in order to manage domestic political tensions.
“If governments respond by enacting policies that divert growth from other countries, this ‘beggar my neighbour’ tactic will simply foster instability elsewhere. What we need, therefore, are new rules of the game,” he said.