03 August 2009

Global Financial Crisis: Questioning the questions

How has the crisis changed our thinking? Are we still asking the wrong questions? What implications does this have for policy making? RBI Governor sets out the right questions to ask in a lecture titled 'Global Financial Crisis: Questioning the questions':

Some excerpts:

Notwithstanding reams being written about resolving the present crisis and preventing another like this, global imbalances are not on the radar screen of policy debate. This is both perplexing and disturbing. Indeed, once the immediacy of the crisis is behind us, it will not be surprising if we head for another round of destabilizing global imbalances.

Resolving the problem of global imbalances does not mean eliminating them. As long as there is world trade, certain countries will have surpluses and certain others will run deficits. Global imbalances have been, are, and will continue to be inevitable.

So, to ask how we can eliminate global imbalances is clearly the wrong question. The right question is this: given that global imbalances are inevitable, how do we ensure that they do not build up to destabilizing levels?


The current monetary and fiscal stance is, however, not the steady state. The Reserve Bank needs to roll back the special monetary accommodation. For this to happen, there are two necessary conditions. First, the government will have to show a firm and credible commitment to fiscal responsibility by fleshing out the road map for fiscal consolidation. Second, there will have to be more definite signs of recovery. The Reserve Bank will maintain an accommodative stance until demand conditions improve and credit flow takes hold, but reversing the expansionary policies is definitely on the agenda on the way forward.

…there will need to be increasing coordination between monetary and fiscal policies. Central banks will have to take into account fiscal compulsions in their monetary stance while governments will need to commit to strict fiscal responsibility. To ask therefore how monetary and fiscal policies can go their separate ways is the wrong question. What is the right question? I submit the right question is: how can we coordinate fiscal and monetary policies to achieve the planned outcomes?


In a more global context, given the fall out from the crisis, to ask how central banks should revert to their sole inflation targeting mandate is the wrong question. The right question is this: what are the specific roles and responsibilities of governments and central banks in ensuring price stability, financial stability and macroeconomic stability?


The magic of the financial sector gave it such a larger than life profile that we began to believe that for every real life problem, no matter how complex, there is a financial sector solution. Now, of course, we know better – for every real life problem, no matter how complex, there is a financial sector solution, which is wrong...

.... However, our problem is a little different since we must regulate markets in a way that does not hamper development. But whose development do we focus on? As I have argued, what is important is the development of the real sectors not of the financial sector. To the extent that the financial sector helps deliver stronger and more secure long-term growth, its development is important. And our regulatory framework should be premised on this underlying argument. So, as we change or review our regulatory framework, the question we need to answer is whether an existing practice or a change in rule delivers higher and more secure real economy growth; not whether it develops the financial sector or accelerates its expansion.

All in all, this crisis has dealt a harsh blow to our confidence in the financial sector. But are we asking the right question? The question we are asking is how to put the financial sector back on the high growth trajectory. I believe we must be asking a different question, so that we can come up with effective and lasting solutions. That question is: how can we keep real sector growth on a high trajectory? And only in this connection, should we ask what the financial sector can do to help.

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