Raghuram Rajan, former Chief Economist at the International Monetary Fund (IMF) and former Governor of the Reserve Bank of India (RBI), has issued a call for central banks worldwide to raise their intervention thresholds. This recommendation comes on the heels of Jerome Powell’s speech at Jackson Hole, where the U.S. Federal Reserve Chair hinted at possible interest rate cuts.
In a recent opinion piece published in the Financial Times, Rajan lauded the Fed’s achievement in taming inflation, which declined from 9% in June 2022 to below 3% the following month. However, he cautioned about potential risks, particularly those stemming from persistent inflation in services and housing.
Rajan illuminated how the pandemic and the Ukraine war impacted supply and demand, leading to inflationary pressures. He observed that most of the disinflation occurred naturally, without significant intervention from the Fed. He also noted that despite the Fed’s efforts to control demand, sectors like automobiles have witnessed a surge in sales since the central bank commenced raising rates. Rajan attributed this to an expansion in supply within the U.S. economy driven by immigration and productivity enhancements.
However, Rajan expressed apprehension regarding the financial sector’s leverage, which has not experienced a substantial reduction despite central bank initiatives. He warned that economic stabilization could ironically escalate the risk of financial instability. Rajan concluded by stating, “None of this, of course, is to suggest that central banks should engineer an economic downturn to cleanse the financial system. It does mean, however, that they should raise the bar on intervening whenever it gets into trouble. As with forest fires, small conflagrations can prevent a larger one.”
Rajan’s comments are particularly pertinent as central banks globally navigate the aftermath of the pandemic. In August, Powell alluded to potential interest rate cuts in September, while the European Central Bank maintained interest rates at their current levels, leaving markets uncertain. Meanwhile, the Bank of Japan is expected to postpone further interest rate hikes until 2025, prioritizing market stability.
In a recent survey, central bank reserve managers identified geopolitical conflicts as the primary threat to the global economy, prompting a shift towards investment diversification across various regions and currencies.
