- August 6, 2014, 7:12 AM ET
RBI’s Rajan Sees Risk of Financial Markets Crash
ByGabriele
Parussini
Reserve Bank of India Governor
Raghuram Rajan warned Wednesday that the global economy bears an increasing
resemblance to its condition in the 1930s, with advanced economies trying to
pull out of the Great Recession at each other’s expense.
The difference: competitive monetary
policy easing has now taken the place of competitive currency devaluations as
the favored tool for playing a zero-sum game that is bound to end in disaster.
Now, as then, “demand shifting” has taken the place of “demand creation,” the
Indian policymaker said.
As was the case in the 1930s, the
lack of coordination between policymakers is producing spillovers that may be
difficult to control, and the world’s financial system may soon face fresh
turbulence at a time when central banks have yet to repair the damage that the
2008 financial crisis caused to developed economies.
“We are taking a greater chance of
having another crash at a time when the world is less capable of bearing the
cost,” said Mr. Rajan in an interview with the Central Banking Journal.
A sudden shift in asset prices could
happen in a variety of ways, Mr. Rajan said. The most obvious route would be as
a result of investors chasing higher yields at a time when they believe central
bank policies will protect them against a fall in prices.
“They put the trades on even though
they know what will happen as everyone attempt to exit positions at the same
time – there will be major market volatility,” said Mr. Rajan.
A clear symptom of the major
imbalances crippling the world’s financial market is the over valuation of the
euro, Mr. Rajan said.
The euro-zone economy faces problems
similar to those faced by developing economies, with the European Central
Bank’s “very, very accommodative stance” having a reduced impact due to
the ultra-loose monetary policies being pursued by other central banks,
including the Federal Reserve, the Bank of Japan and the Bank of England.
“The exchange rate is too strong
given the euro area’s economic standing,” said Mr. Rajan, who took over the RBI
in September.
Mr. Rajan said economists still
disregard the central role of financial systems in the economy and believe they
can predict upcoming disruptions.
“They still do not pay enough
attention–en passant–to the financial sector,” Mr. Rajan said. “Financial
sector crises are not as predictable. The risks build up until, wham, it hits
you.”
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