A Lot At Stake

The very phrase "monetary policy" sounds technical and sleep-inducing, but it is an extremely vital issue that impacts the lives of everyone, particularly the poor, because of its immediate effect on inflation. It also affects the very structure of society due to its longer term impact on resource allocation. In a true sense, control of money is the control of society.

Raghuram Rajan's philosophy is fundamentally different from the Bernanke-Yellen-Draghi-Kuroda consensus of "activist" or "solve all the world's problems" monetary policy that has wreaked so much havoc in the world. Rajan's monetary policy is far more intellectually humble, focused on narrow goals of (a) keeping the value of the currency stable and inflation low; (b) keep the debt level in the financial system manageable. In contrast, activist central bankers, who run much of the world outside India, have created a historic global debt bubble. The last chapter in this monster debt saga is yet to be written, which is why it is urgent for India to keep itself relatively insulated from the effects of this bubble bursting.

This is how the story begins: in the classic formulation of Bernanke and Greenspan, activist or asymmetrical monetary policy asserts, "Refuse to recognise a bubble or fight it as it is expanding, and instead flood the system with money when a bubble bursts." This policy results in keeping interest rates low across the business cycle, leading to unsustainable debt accumulation. Rajan warned the US Fed policy makers of the potential for a catastrophic collapse as early as 2005, but he was ignored.

Politicians of all stripes initially find the easy money policy convenient, but that temporary convenience is bought at the price of long stability of the economic system itself. Repeat the policy over multiple business cycles, the economy becomes addicted to cheap credit, and ever more doses of this powerful and destructive drug is needed to keep the high. The end result is "central bank socialism" - central banks become the only game in town, and the political class gets neutered, leading to policy paralysis and even more central bank activism, a situation that is already evident in the US, Europe and Japan.

While Bernanke or Yellen or Draghi would pay occasional lip service to the limits of their powers - what a central bank could achieve - in practice, their intellectual conceit led them to targeting the GDP, employment levels, asset prices and financing bail-outs, in an endless orgy of money printing, the greatest monetary and credit explosion the world has ever seen. With their reckless adventurism, central bankers usurped what was legitimately the domain of elected governments, sucking the oxygen out of the political economy, substituting it with their monetary emissions.

Central bank socialism has led to crony capitalism, extreme rise in inequality, the erosion of the middle class and a rise in social unrest. A frustrated citizenry that has experienced its living standards progressively eroded has found new outlets in populist movements of all stripes. In that sense, activist central banking has led to a crisis of faith in democracy itself.

In contrast, Rajan's monetary philosophy is intellectually humble and is perfectly consistent with Prime Minister Modi's philosophy of "minimal government and maximal governance". Indeed, it is the coherence of the two philosophies that has kept India stable, in a world that is going mad. While Modi focuses on the urgent task of economic construction, Rajan set a stable course for the rupee, kept inflation low, helping hundreds of millions of Indian poor.

With Rajan's departure, I hope India does not fall victim to the global activist central banking mind set. Rajan, due to his track record, had the intellectual independence and stature to chart his own course for the RBI. While that course occasionally caused discomfort to politicians, the humbler, narrowly-focused monetary policy leaves the important political economy decisions to be made by the elected government, which is exactly as it should be in a democracy. It is not a coincidence that Modi is seen as one of the most effective leaders in the world today.

The real legacy of Rajan's tenure at the RBI is the lesson that India should avoid central bank socialism. What is at stake is the very future of our political economy, our ability to achieve broad-based inclusive economic growth, and prosperity for 1.2 billion people.

The author is Founder & CEO, Zoho Corp.