Low interest rates can cause financial crisis too: Rajan

Frankfurt, Germany: The new head of India’s central bank is questioning whether current ultra-low interest rates are the right way to return to growth after the financial crisis.

Raghuram Rajan, the head of the Reserve Bank of India, says central banks warded off a collapse of the global financial system through bank bailouts and rate cuts. Central bankers, he said, were “heroes” for halting the collapse.

But global growth since then has been disappointing and Rajan said it was time to ask if there were better tools than the rock bottom rates used by major central banks in the rich world, including the US Federal Reserve, Bank of England, Bank of Japan, and European Central Bank.

Rajan said low rates could have unintended consequences. He says, for instance, that they could encourage people in their 60s to save instead of spend - because the low returns mean they are unable to reach their retirement savings goal.

At a speech in Frankfurt, Rajan said he didn’t have the answers but said it was time to ask, “are ultra low rates the solution or part of the problem?”

Low rates can encourage banks and financial institutions to take more risks in investing - but Rajan questioned whether that was leading to an increase in new investment and risk-taking by businesses. “There may be no connection or only a limited one, if uncertainty holds back investment,” he said.

He underlined that low rates “do create financial system stresses which could set the stage for another crisis.”

Appearing at Frankfurt’s Goethe University to accept the Deutsche Bank prize in financial economics, Rajan said he was making a last speech as an academic economist instead of as a central banker. Rajan, the former chief economist at the International Monetary Fund, won plaudits for predicting the possibility of a global financial crisis before the 2007-9 turmoil began. He is on leave from his post as finance professor at the University of Chicago.

He took over his post as head of the Reserve Bank of India this month and immediately faced high inflation, a plunging rupee currency and sub-par growth. The bank raised its benchmark interest rate last week by a quarter point to 7.5 percent, sending a message it intends to fight inflation.

He suggested that other tools - such as targeted government spending on unemployment insurance and relief for people in debt - might help spending and growth. But he also warned that too much stimulus, especially in emerging markets, had been the root of much of the trouble after the crisis. In his own country, “there were three stimulus packages, probably two too many compared to what we needed.”

AP