General Direction of Modi’s Reforms has Been Positive
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:
ON INDIAN ECONOMY
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.