Good question to ask if more stimulus is the answer: Raghuram Rajan to ECB

Paris: The International Monetary Fund and the United States encouraged the European Central Bank and the Bank of Japan toward greater monetary stimulus on Friday and urged governments around the world to do their share to cultivate growth in their countries.

Calling the world economy “fragile, brittle and fragmented”, IMF Managing Director Christine Lagarde told a conference of central bankers in Paris it was “perfectly legitimate and appropriate” for the ECB and the BoJ to take unconventional steps to combat low inflation and economic stagnation.

US Federal Reserve Chair Janet Yellen said central banks"need to be prepared to employ all available tools, including unconventional policies, to support economic growth and reach their inflation targets," especially where governments have withdrawn fiscal stimulus.

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The comments came a day after the European Central Bank ordered its staff to start preparing for bolder measures if needed to fight slowing inflation, on top of a range of rate cuts, asset purchases and lending operations already agreed.

However, Indian central bank governor Raghuram Rajan said whether “more stimulus is the answer” was a good question. More economic reforms were equally important, he said.

Lagarde said governments with healthy budget positions should do more to support growth, describing as insufficient a German announcement of an extra 10 billion euros in spending on public infrastructure over the next three years.

“In this part of the world, we have to repeat over and over that monetary policy cannot be the only game in town, and that there has to be a combination of sound fiscal policies, use of fiscal space for those countries that have fiscal space in order to support growth and rejuvenate that growth,” she said.

“Clearly, the announcement that was made yesterday was in the very small ballpark of what will be needed in order to do that.”

ECB Governing Council member Christian Noyer said central banks, including his own, should be prepared to buy public debt if needed to avert deflation or a run on sovereign bonds.

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“Such an action may be vindicated if there are risks to macroeconomic or financial stability or even if self-fulfilling runs on public debt may be a threat to market access, or lastly to avoid the deflationary consequences of a public debt event,” Noyer told the conference.

Bumpy transition

Other speakers warned that the impact of the world’s major central banks taking divergent policy directions after a long phase of easy money could cause turmoil among currencies and increase volatility across the financial markets.

Bank of England Governor Mark Carney spoke of a probable “bumpy transition” between a period when markets have been awash with cheap central bank liquidity and a return to more normal monetary conditions.

“We’re in this - with some exceptions - low-volatility, compressed-spread environment, particularly around liquidity premia. That’s going to change as things normalize,” said Carney, who also chairs the global Financial Stability Board.

“But that reality, or that likelihood, shouldn’t, in my view, impact the timing of the start of normalization.”

The US Federal Reserve Bank ended a multi-year bond-buying program last week, although its policymakers differ about the timing and pace of future interest rate rises.

New York Fed chief William Dudley told the conference the Fed was likely to raise U.S. interest rates “sometime next year” and investors seemed to be getting the message of patience in this policy-tightening cycle.

Mohamed El-Erian, an economic adviser to German insurer Allianz and former co-chief of bond giant Pimco, said central bankers should not underestimate the risk of currency market swings as their monetary policies take divergent paths.

“As much as these currency moves may contribute to global rebalancing on paper, I would just caution from a market perspective not to underestimate … the speed and size of currency moves,” he said.

No alarm over euro

The euro fell to its lowest level since 2012 on Thursday, below $1.24, after ECB President Mario Draghi announced the unanimous determination of the bank’s policy-setting council to take further unconventional measures if necessary to combat a slowdown in inflation.

The ECB has begun a new wave of unlimited four-year cheap loans to banks in an effort to revive lending to businesses. It has now added purchases of covered bondsand is set to buy the bundled loans known as asset-backed securities.

Draghi effectively committed the bank to boost its balance sheet by about 1 trillion euros ($1.24 trillion), toward the levels it had at the peak of the euro zone crisis in 2012, through those measures, and through others if they fell short.

But while the euro has dropped some 11 percent of its value against the dollar this year, it has not provoked undue alarm from Europe’s trading partners so far.

Central bankers said the issue arose on the sidelines of the annual IMF meetings in Washington last month, but other major economies understood that a weaker euro was preferable to seeing deflation in the euro area.

BOJ Governor Haruhiko Kuroda, chairing one of the sessions, hinted that the Japanese government should move faster to open up the economy to more competition to boost growth. His comments come after the Bank of Japan decided to expand its monetary stimulus policy to try to lift an economy still struggling to emerge from a decade of deflation and economic stagnation.

Lagarde said the Tokyo government should move ahead with its commitments to raise consumption tax and make more space for women in the Japanese economy.

Reuters