Banker with a cause
Raghuram Rajan’s book I do what I do (HarperCollins, 2017) is a collections of talks, lectures and papers, some of which have been in the public domain for a while by now. Between these articles this former Governor of the Reserve Bank of India covers much territory. He champions the spread of banking emphasising the importance of “innovation in reaching out to the underserved customer”. We find a clear-sightedness about dealing with the ‘bad-loans’ problem. We are told of the importance of “early recognition of distress and fair treatment of lenders and borrowers”. As he sees it the task of policy is to “help those with difficulty while being firm with those trying to milk the system.” Finally he speaks of the “miasma of suspicion” that pervades public action in India, holding us back as a society, and of attempts by the bureaucracy to tie down the RBI. Every one of these ideas is worth reflecting upon seriously.
Mr. Rajan’s cause, however, is the control of inflation. It is also the topic on which he is least original. Though he is not above taking the occasional swipe at the “Keynesian economist” he makes light of his own allegiance to the work of Milton Friedman, which should leave him a ‘New classical macroeconomist’. The issues are somewhat technical here, and the reader must bear with the detail as there is no shortcut to understanding them.
We are in this book presented with the standard tropes of the inflation warrior. First there is some scare mongering. We are told that high inflation “feeds on itself” and transported to the experience of hyperinflation in the Weimar Republic. Taking this route however is akin to using the experience of the Great Recession to recommend the permanent nationalisation of banking in market economies. Then we are treated by the author to Friedman’s interpretation of the observed positive relation between inflation and unemployment known as the Phillips Curve. The interpretation is that unemployment falls below the ‘natural rate’ only because workers do not anticipate inflation. Now the task of the central bank is to maintain stable inflation so that workers can go back to the level of employment they desire. This account begs the question of involuntary unemployment, a situation in which workers are willing to work at the current money wage but cannot find employment. Secondly, it treats the inflation rate – allegedly picked by mischievous politicians - as independent of growth rather than being generated along with it. Finally, there is the age-old argument of how high inflation is variable and therefore leaves producers unable to distinguish between changes in the relative of their product and the general price level. In reality, one would have thought, there is no reason to fear this possibility as the producer need go only so far as the excellent website of the RBI to know the current inflation rate!
Having taken us so far as to recognise a role for relative prices Mr. Rajan fails to point out their role in making people fear inflation. Actually, when relative prices change we fear that others may be gaining at our expense. This makes it a bombshell in a democracy. But it is also true that when inflation is generated jointly with rising employment, as we have reason to believe, curbing aggregate demand makes any involuntarily unemployed workers worse-off while benefiting the holders of financial wealth. It is the power of the financial sector in Anglo-American capitalism that has led to inflation control becoming the centrepiece of public policy in recent times. None of this is to play down the harmful effects of inflation. It only queries a single-minded focus on the inflation rate to the exclusion of growth.
As a professional of the highest class Mr. Rajan, naturally, insists on evidence. The evidence though is poor for his view of what determines inflation in India. Rather than too high an output level – “overheating” - it is often its decline, especially in the agricultural sector, that drives inflation here. My work with M. Parameswaran of the Centre for Development Studies at Thiruvananthapuram shows that the relative price of agriculture and the price of imported oil dominate the ‘output gap’ as drivers of recent inflation in India. This somewhat weakens the case for the approach to inflation proposed by Mr. Rajan, and practiced by the RBI when he was Governor, namely ‘inflation targeting’. Once again, this does not weaken the case for inflation control per se. It only signals the need for management of agricultural supplies and, as the Americans have shown, weaning the economy away from imported oil. But the evidence I have cited should make us doubt the confidence placed on the power of monetary policy in tackling inflation in India.
Finally, while Mr. Rajan is absolutely right to claim that inflation was lower by the end of his tenure, it had already begun to decline, though mildly yet, when he took over. Indeed his effort was aided by a steady decline in the relative price of agricultural commodities and the price of imported oil, trends lasting throughout his three years Governor. In general, Mr. Rajan recounts his actions as Governor and assesses their impact, mostly dispassionately except in the case of inflation control where he simply assumes that the outcome reflects the Bank’s prowess. There is also no acknowledgement that the growth slowdown that is being talked about today had commenced in his tenure, even as the inflation rate declined.
Mr. Rajan writes with much clarity and has a good style. My estimation of his readable book is that it is great on finance but less convincing on the macroeconomics.