MONETARY POLICY, SOVEREIGN DEBT AND FINANCIAL STABILITY: THE NEW TRILEMMA
Editor: Deepak Mohanty
Foundation Books
Pages 370, Rs 995
This book consists of 10 papers focussing on the theme embodied in the title, from different perspectives. As with all Reserve Bank of India (RBI) publications, the introductory chapter carries a brief yet comprehensive summary of the central thrust of the papers.
The first paper by the former governor, D Subbarao, elaborates on how the Lehman crisis followed by the Euro zone debt crisis changed the theology of central banking in a fundamental way. Post-Lehman, financial stability drew attention. He also highlights how the Euro zone Sovereign debt crisis opened the eyes of the central bankers to the concerns arising out of sovereign debt sustainability and its linkages with financial stability. In the later pages he articulates apprehensions about how the US Federal Reserve/European Central Bank steps to secure financial stability could endanger price stability thus introducing the 'Trilemma'. A detour into the etymology of Trilemmas as also a discussion of Mundell's famous 'impossible' trinity before moving onto Subbarao's Holy Trinity, makes it a lively piece, which concludes by evaluating whether the pursuit of the Trilemma militates against growth and concludes that it will not.
Deepak Mohanty's paper represents a comprehensive review of how RBI's experiences vis-a-vis the efficacy of the interest rate channel resulted in policy evolution. The paper has a historical summary of RBI measures, regarding price stability from 2001. The paper also analyses the impact of policy rate increases on output growth (negative with a lag of two quarters) and inflation (moderating with a lag of 3 quarters).
Yung Chul Park attempts to examine from an emerging market perspective, mainly Korean, the rationale and scope of a macro prudential policy framework. The dilemmas encountered in tackling asset price bubbles are articulated using Korean experiences with reference to housing speculation.
Stephen G Cecchetti and Enisse Kharroubi question the often widely stated thesis that financial sector development is good for growth as it reduces transaction costs and raises investment directly while improving the distribution of capital and risk across the economy.
Jorgen Elmeskov and Douglas Sutherland study the growth implications of the post-crisis debt hangover in OECD countries: articulating the complexities faced when several countries are simultaneously pursuing fiscal/macroeconomic consolidation and the interrelation of such policies on aggregate demand and growth.
Benjamin M Friedman examines and questions the widely-held perception that the low short-term interest policies of the US Fed of early 2000s were the most important reason for the events leading up to the financial crisis. The view regarding the link between low short-term interest rates and housing bubbles, though plausible, lacks empirical support, underlining the need for central banks and academics to undertake empirical and conceptual research to explore how well the existing financial sectors are performing their fundamental economic functions.
The two papers by William R White and Parthasarathi Shome, respectively, are on policy errors in the advanced economies and the course of public debt growth and the attendant spillover effects. Shome articulates that perhaps EME's erred in going along with the advanced economies in adapting "fiscal stimulus" policies to recover from the crisis, noting that there is no proof that India, in particular, needed to reverse the fiscal stance adapted under the FRBM Act in order to recover from the crisis.
This is followed by a deeply reflective paper by Barry Eichengreen, Eswar Prasad and Raghuram Rajan on the connections between various facets of central banking. Recognising that financial stability can no longer be seen outside the direct ambit of monetary policy and the need to address the issue of cross-border spillovers and their complexities, the authors articulate the need for an alternate governance framework to address concerns of financial stability without compromising the price stability objective.
The final paper by Frank Smets and Mathias Trabandt discusses the interaction between high sovereign debt and monetary policies in the advanced economies.
What is intriguing about the book is that though the papers, taken by themselves, are worth reading, the volume as a whole seems to have encountered the Holmesian dilemma (of the dog that did not bark) while exploring aspects of the trilemma.
Mohanty brings out that Governor Subbarao's famous baby steps to control price inflation had started as early as December 2010. Thirteen repo rate increases had taken place by the time the conference took place in February 2012. Several subsequent steps, apparently on the same premises, have also been taken by RBI and yet the problem has not gone away. Should not a book on financial stability published in February 2014 have wondered why?
