Communication between central bankers is important. It must go on.
RBI governor Raghuram Rajan drew attention to an old but crucial debate when, at a Brookings Institution event last week where former US Federal Reserve chairman Ben Bernanke was also present, he suggested that advanced economies should consider the effects of their domestic stimulus policies on emerging markets. Rajan’s critique of the spillover effect of US monetary policy and his call for greater coordination between central banks and the creation of a “safety net” were countered by Bernanke.
Admittedly, heads of advanced economy central banks are also constrained by their legal mandates — the Fed chairman must maintain price stability and maximise employment in the US. It could even be argued that the interests of advanced and emerging economies are often better aligned than they’re made out to be. Yet Rajan’s concerns about volatility in the emerging markets are valid, and India is fortunate to have a central banker of his stature to draw international attention to them.
Ever since the first round of quantitative easing began, Bernanke has stressed that the purported trade-off was exaggerated, that QE was not having a major destabilising effect on emerging markets. Indeed, at the 2012 IMF/World Bank Group annual meetings in Tokyo, Bernanke emphasised that a limp US economy would hurt emerging markets because demand for their exports would be weak.
And insofar as QE would revive export demand in the US, it would have a positive externality on emerging markets. The emerging market point of view, however, most forcefully presented by the Brazilian central bank president, Alexandre Tombini, was that the currency appreciation as a result of QE was hurting their exports and making them vulnerable to volatility when the Fed would trim its bond-buying programme.
Even as rearranging the rules of the game to allow for greater global coordination of monetary policies may be a long-term solution, volatility remains an immediate challenge for emerging economies, especially as interest rates in the US are set to increase. To counter it, the RBI must focus on keeping inflation in check.
If inflation in India is too high, the rupee will appreciate in real terms, and when US interest rates start increasing, it may depreciate sharply in nominal terms to correct for this. The RBI should also allow the exchange rate to float freely so that it is not artificially propped up or misaligned. As long as inflation is under control, the exchange rate unpegged and the current account deficit under check, the rupee can remain more or less stable.