‘Fi­nan­cial cri­sis re­sults from what you don’t see’

Business Standard - - FRONT PAGE -

KEN­NETH ROGOFF, for­mer chief econ­o­mist at the In­ter­na­tional Mon­e­tary Fund, be­lieves the best of cen­tral banks could be hob­bled by lack of po­lit­i­cal back­ing. He speaks to Sachin P Mam­patta about de­mon­eti­sa­tion, the in­de­pen­dence of cen­tral banks and the prob­lem with gen­er­als fight­ing the last war rather than the next one.

KEN­NETH ROGOFF, pro­fes­sor of eco­nomics at Har­vard Univer­sity and for­mer chief econ­o­mist at the In­ter­na­tional Mon­e­tary Fund (IMF), be­lieves that the best of cen­tral banks could be hob­bled by a lack of po­lit­i­cal back­ing. This could play a crit­i­cal role in han­dling the next cri­sis, which he be­lieves may come sooner than one ex­pects. Speak­ing to Sachin P Mam­patta, on the side­lines of an ICICI Lom­bard Gen­eral In­sur­ance Com­pany event, he talked about de­mon­eti­sa­tion, the in­de­pen­dence of cen­tral banks, and the prob­lem with “gen­er­als fight­ing the last war rather than the next one”. Edited ex­cerpts:

You have sug­gested that the next fi­nan­cial cri­sis may hap­pen sooner than later. What do you think might trig­ger it?

There have been many good changes that have taken place. The bank­ing sec­tors across the world take less risk, have more liq­uid­ity and are more tightly reg­u­lated. But there are still many risks in the sys­tem. Fi­nan­cial cri­sis of­ten re­sults from what you don’t see rather than what you do see. Gen­er­als tend to fight the last war, not the next one. I think what con­cerns me the most is not so much the risk that some­thing will be sparked as weak­ness of the peo­ple who would be deal­ing with it. The cen­tral bankers are very good. They are very good at the Fed­eral Re­serve, they are very good at the Eu­ro­pean Cen­tral Bank but they can­not deal with crises alone. They need power. When Draghi (pres­i­dent of the Eu­ro­pean Cen­tral Bank) said ‘what­ever it takes,’ he only could say that when Merkel (Ger­man chan­cel­lor) said that he could.

When Ber­nanke (chair­man of the Fed­eral Re­serve) was freely buy­ing gov­ern­ment debt, he could only do that when the US trea­sury said, ‘please do that.’ And, they could only say that when the Pres­i­dent said that. You need po­lit­i­cal sup­port at many lev­els. Of­ten a prob­lem needs to be dealt with cre­atively. There’s not al­ways a play­book which you can fol­low. And, I just don’t know who the adults in the room will be when it hap­pens.

There’s been a de­bate in In­dia about the in­de­pen­dence of the cen­tral bank. How big a role would you think that might play, as far as emerg­ing mar­kets like In­dia are con­cerned, dur­ing the next cri­sis?

I wrote the aca­demic the­ory of in­de­pen­dent cen­tral banks in the mid-eight­ies. So, I think it’s very im­por­tant. I think the de­vel­op­ment of In­dia’s in­fla­tion tar­get­ing frame­work has been a huge step to­wards sta­bil­i­sa­tion in In­dia – to the ex­tent that there are con­cerns about the in­de­pen­dence of the In­dian cen­tral bank (in the con­text of Ur­jit Pa­tel step­ping down). That’s a step back­wards. I don’t know what the re­al­ity is, but cer­tainly from the out­side world it didn’t look good.

These things have hap­pened in other places, and if they con­tinue their in­fla­tion­tar­get­ing frame­work, and con­tinue do­ing what they are with bank­ruptcy, it should all be fine. But when you have not just a cri­sis, but a re­ces­sion, the cen­tral bank’s cred­i­bil­ity is in­cred­i­bly im­por­tant. I think it’s been one of the great in­sti­tu­tional de­vel­op­ments of the last 30 years. All over the world, there were very few in­de­pen­dent cen­tral banks and now I think they are here to stay.

What’s your per­spec­tive on de­mon­eti­sa­tion two years af­ter the ex­per­i­ment?

My col­league Gita Gopinath has a pa­per on this. Her re­sults are sim­i­lar but a lit­tle stronger than what oth­ers have found, which is that the short-run costs were sig­nif­i­cant to the econ­omy.

In my book about re­duc­ing cash, I’m ac­tu­ally very cau­tious to say, first of all, if you’re an emerg­ing mar­ket be very care­ful about do­ing this. You shouldn’t do it overnight. You should take five to seven years. I think on its own, its hard to un­der­stand. If you look at it in the larger con­text of other re­forms that the gov­ern­ment’s made – anti-cor­rup­tion, the GST (goods and ser­vices tax), the bank­ruptcy changes, the Aad­haar sys­tem – there have been many good things hap­pen­ing. De­mon­eti­sa­tion is more of a po­lit­i­cal event but it’s not in line with how I would have ad­vised do­ing it, had some­one asked me. But no­body did.

You’ve talked about the need to phase out large de­nom­i­na­tion cur­rency.

Of 50 to 100 dol­lars…which you didn’t have in In­dia. The (de­mon­e­tised) notes were worth 7 to 15 dol­lars at that time. It’s cer­tainly true that when you can move the econ­omy to­wards be­com­ing cash less, you’ll re­duce cor­rup­tion and in­crease tax col­lec­tion. I think the spirit of that is right. But on the tac­tics, I’m not in charge of gov­ern­ing a coun­try of 1.3 bil­lion peo­ple and (don’t) un­der­stand all the is­sues. But it’s cer­tainly not the way de­mon­eti­sa­tion is done; it was done hy­per-fast. My book says do it very slowly. In­dia is an emerg­ing mar­ket and my book says this is for ad­vanced coun­tries.

Global cen­tral banks are ex­pected to tighten the screws now. How do you see emerg­ing mar­kets like In­dia be­ing af­fected by it? We’ve seen the Re­serve Bank of In­dia cut­ting in­ter­est rates by 25 ba­sis points. Is that the direc­tion you would ex­pect to see, broadly, in terms of emerg­ing mar­kets, dur­ing a pe­riod of tight­en­ing liq­uid­ity glob­ally?

I don’t know when the tight­en­ing of liq­uid­ity is go­ing to hap­pen be­cause the Fed­eral Re­serve did a sud­den about-face, it’s al­most in­com­pre­hen­si­ble. It was as if they had put their foot on the ac­cel­er­a­tor and then slammed on the brakes. I don’t know what’s go­ing on. They don’t seem to be tight­en­ing.

The ECB (Eu­ro­pean Cen­tral Bank) doesn’t seem to be tight­en­ing. Ja­pan doesn’t seem to be tight­en­ing. So, I think this idea that we are in a global tight­en­ing cy­cle is on pause. As a re­sult, there is less pres­sure on emerg­ing mar­kets. It’s very help­ful.

Dol­lar tight­en­ing, es­pe­cially, is very painful for all emerg­ing mar­kets. It puts pres­sure on ex­change rates, it puts pres­sure on trade. And, I think it’s a sig­nif­i­cant re­lief. But I’m not sure that the Fed­eral Re­serve left it­self in a good po­si­tion if there is in­fla­tion. Then sud­denly, they might have to press on push­ing rates up even faster than they did be­fore. So, we’ve created a vul­ner­a­bil­ity pos­si­bly lead­ing to a faster stop later.

Any views on the In­dian econ­omy?

Well, it’s the fastest, one of the best per­form­ers in the world. When I came here in 2002, I said you can grow at eight per cent. And I was told that was crazy, and (now) here we are.

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