Gen­eral Di­rec­tion of Modi’s Re­forms has Been Pos­i­tive

The Economic Times - - Money -

It will be valu­able for the Fed to start cut­ting its bal­ance sheet sooner rather than later so that they can do it gen­tly in the back­ground with­out scar­ing the mar­kets like in 2013, said Randall S Kroszner, an eco­nom­ics pro­fes­sor at the Univer­sity of Chicago’s Booth School of Busi­ness. In an in­ter­view with Nis­hanth Va­sude­van on the side­lines of a re­cent CFA So­ci­ety In­dia event, Kroszner, a for­mer Fed­eral Re­serve gov­er­nor, said the Fed is pre­par­ing the mar­kets well for rate in­creases. Edited ex­cerpts:


What is your as­sess­ment of the US Fed’s out­look for in­fla­tion and in­ter­est rates? The Fed is fi­nally con­vinced about the strength of the re­cov­ery. This re­ally came in the be­gin­ning of March when it made it very clear it is go­ing to raise rates in March. The em­ploy­ment data has been the most im­por­tant data re­cently in ad­di­tion to the in­fla­tion num­bers. One of the things I look at is not just the tra­di­tional un­em­ploy­ment rate. There is a broader mea­sure of un­em­ploy­ment, tech­ni­cally known as U-6. Th­ese in­clude peo­ple who are part time and want to be full time and also those who have not looked for work in the last one month. That num­ber is dra­mat­i­cally higher. So, if you look at the tra­di­tional un­em­ploy­ment rate, it’s be­low 4.5%. Un­til very re­cently, this num­ber was above 9%. If you look over the 25-year his­tory be­fore we had the fi­nan­cial cri­sis, the dif­fer­ence be­tween the tra­di­tional un­em­ploy­ment rate and the broader mea­sure was typ­i­cally above 4%. Since the fi­nan­cial cri­sis, the dif­fer­ence has been much wider. Now, this dif­fer­ence is shrink­ing to a lit­tle over 4%, al­most back to its tra­di­tional re­la­tion­ship. That’s the con­di­tion un­der which the US is likely to see some wage pres­sure. So, I think it is wise on the part of the Fed to an­tic­i­pate some wage pres­sure com­ing in and be ahead of the curve.

Fed had said it will start trim­ming its bal­ance sheet rel­a­tively soon... The Fed is prob­a­bly likely to start it in Septem­ber. But, they have made it clear that they are go­ing to do it ex­tremely gen­tly. As one of the mem­bers of the FOMC had said, “We want to make it as ex­cit­ing as watch­ing the paint dry”. This means it is hap­pen­ing in the back­ground and no one will pay at­ten­tion to it. We will have to see how they achieve in the ex­e­cu­tion. They won’t down­size the port­fo­lio un­til 2021-2022. But it’s valu­able that they start sooner rather than later so that they can do it gen­tly in the back­ground with­out scar­ing the mar­kets like in 2013.

So far, global fi­nan­cial mar­kets have re­mained calm de­spite Fed talk of higher in­ter­est rates. Is it com­pla­cency or are mar­kets pre­pared? Part of it is that rate in­creases have been so well an­tic­i­pated. The Fed has been at pains to tele­graph this long in ad­vance and so no one has been caught by sur­prise. That’s why we are not see­ing the kind of tu­mult like the ta­per tantrum we saw in 2013. Also, the eco­nomic con­di­tions are very dif­fer­ent from that in 2013. We have pretty strong global growth in­clud­ing in the US, Europe and emerg­ing mar­kets bar­ring ex­cep­tions like Brazil and some other smaller coun­tries.

Will mon­e­tary pol­icy de­ci­sions of emerg­ing mar­ket cen­tral banks like the RBI be driven by Fed’s moves? The key will be with what hap­pens to in­fla­tion. If in­fla­tion con­tin­ues to stay at low lev­els and is not be­cause of tem­po­rary fac­tors, it will al­low the RBI to re­duce rates. What de­ter­mines the flows is the in­fla­tion-ad­justed rates. That’s the key thing. So, RBI will cut rates if in­fla­tion is low even if the Fed is in­creas­ing rates.

Yellen’s term is com­ing to an end early next year. What should one ex­pect from a Fed with­out Yellen? The Pres­i­dent (Don­ald Trump) has the op­por­tu­nity to change the ma­jor­ity of the board. And if the Pres­i­dent chooses some­one as chair with a very dif­fer­ent view com­pared to what Yellen has had, mon­e­tary pol­icy could change sig­nif­i­cantly. How­ever, it is un­likely he is go­ing to choose peo­ple who will com­pletely re­v­erse course. He might choose peo­ple who might be more ag­gres­sive in in­ter­est rate in­creases but it will not be a sea change from where we are. But, we don’t know be­cause the Pres­i­dent has said very lit­tle about the Fed.

How do you rate Naren­dra Modi as a reformer? Have his eco­nomic poli­cies been in line with what peo­ple ex­pected? In­dia has cer­tainly seen some re­forms mainly those re­lated to in­sol­vency and bank­ruptcy. That is an im­por­tant step for­ward be­cause there is a clear frame­work with a It will be im­por­tant that they deal with the prob­lem now rather than wait for six months or a year af­ter the Party Congress in the fall. They brought back Mr Guo as the head of China Bank­ing Reg­u­la­tory Com­mis­sion and he has been do­ing an ex­cel­lent job of deal­ing with the so-called wealth man­age­ment prod­ucts where there is a lot of off-bal­ance sheet risks for the banks. This has been go­ing on for the past few months. De­spite that China’s GDP is at 6.9%. So far, he has been able to rein in th­ese credit risks with­out caus­ing any crunch. It is the tightrope that they need to con­tinue to walk. They have done well so far, but they will need to en­sure that debts do not go out of con­trol or re­sult in credit con­trac­tion.

Are there any fault lines like the one Raghu­ram Ra­jan spoke about be­fore the pre­vi­ous fi­nan­cial cri­sis? There are al­ways risks. Gen­er­ally, it’s the risks that you do not see are the ones that cause trou­ble. I think fault lines are there but there are not deep as Raghu (Raghu­ram Ra­jan) had iden­ti­fied in 2000s. So, many of the is­sues Raghu had talked about have not been par­tially ad­dressed. Are we per­fectly safe? For sure not. We will never be. But, we have a much bet­ter bal­ance to­day.

Is Europe out of the woods yet? The eco­nomic fun­da­men­tals have been pretty strong for Europe. The GDP print for Euro­zone was ac­tu­ally stronger than the US. That’s why the ECB at some point will start to pull back. Much like the Fed wants to roll back smoothly, the ECB will also want to do it the same way. Maybe, they will ar­tic­u­late an exit path later this year.

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