The current non-system in international monetary policy is a source of substantial risk both to sustainable growth as well as to the financial sector, Reserve Bank of India (RBI) Governor Raghuram Rajan said on Thursday.
"The current non-system in international monetary policy is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action," he said in his address to the Brookings Institute, a Washington-based think tank.
"We are being pushed towards competitive monetary easing. If I use terminology reminiscent of the Depression era non-system, it is because I fear that in a world with weak aggregate demand, we may be engaged in a futile competition for a greater share of it," Mr Rajan said in his key note address.
"In the process, unlike Depression-era policies, we are also creating financial sector and cross-border risks that exhibit themselves when unconventional policies come to an end. There is no use saying that everyone should have anticipated the consequences."
Rajan said a first step to prescribing the right medicine is to recognise the cause of the sickness.
Central banks, he said, should assess spillover effects from their own actions, not just in terms of immediate feedback, but also in terms of medium term feedback as other countries alter their policies.
"In other words, the source country should not just worry about the immediate flows of capital to other countries from its policies, but the longer run reaction such as sustained exchange intervention that this would bring about," he said.
This would allow central banks to pay more attention to spillovers even while staying within their domestic mandate, he added.
Observing that emerging economies have to work to reduce vulnerabilities in their economies, to get to the point where, like Australia, they can allow exchange rate flexibility to do much of the adjustment for them to capital inflows, Mr Rajan said another way to prevent a repeat of substantial reserve accumulation is to build stronger international safety nets.
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