Insights into Editorial: Governor’s call
25 March 2016
Summary:
Reiterating the deepening challenges facing the global economy, RBI Governor Raghuram Rajan recently argued for a new international agreement, along the lines of the Bretton Woods conference in 1944 that yielded the International Monetary Fund and the International Bank for Reconstruction and Development.
Why do we need such an agreement?
The world today is facing an increasingly dangerous situation. That’s because while all economies, both advanced and emerging, are straining to grow faster, only few are succeeding. As a result few countries have resorted to “beggar thy neighbour” policies, which have proved detrimental for all economies.
What is “beggar thy neighbour’ policy?
A beggar-thy-neighbour policy is an economic policy through which one country attempts to remedy its economic problems by means that tend to worsen the economic problems of other countries.
- Such policies utilize currency devaluations and protective barriers to alleviate a nation’s economic difficulties at the expense of other countries.
- While the policy may help repair an economic hardship in the nation, it will harm the country’s trading partners, worsening its economic status.
What necessitated countries resort to “beggar thy neighbour” policies?
It is the 2008 financial crisis which is to be blamed. In the wake of the 2008 financial crisis, global demand slumped and countries were left with a massive debt. Countries tried to solve this problem by bringing down interest rates. When even bringing down interest rates to zero per cent did not stimulate the economy adequately, central banks went for unconventional tools, such as quantitative easing (QE).
- In essence, QE is the creation of new money. But such unconventional methods have led to the depreciation of the domestic currency and the creation of asset bubbles across the world.
- In return, some central banks have retaliated by allowing their currency to devalue in a bid to corner global exports. But this string of competitive devaluations has brought down the overall level of global employment.
What can be done to improve the situation?
Central banks in developed countries find all sorts of ways to justify their policies. Hence, what we need are monetary rules that prevent a central bank’s domestic mandate from trumping a country’s international responsibility.
In doing so, RBI governor has also called for a new set of rules for assessing policies that are:
- Acceptable (green).
- Acceptable in the short term (orange).
- Not acceptable at all (red).
Conclusion:
However, given the situation, India cannot afford to wait for changes in the global order. India needs to focus on structural reforms, which lie in the domain of fiscal policy and should shore up reforms that “increase competition, foster innovation, and drive institutional change”. Meanwhile, the time is also ripe for building a system fit for the integrated world of the twenty-first century.
