On University of Chicago’s Raghuram Rajan as India’s Central Bank Governor

Austrian economist Peter Klein cheers the appointment of University of Chicago’s finance and banking professor as the Governor of the central bank of India, noting of Mr. Rajan’s familiarity of the Austrian Business Cycle.

Writes Professor Klein at the Mises Blog

Raghu Rajan is a very good neoclassical economist who has made important contributions to banking, finance, the theory of the firm, corporate governance, economic development, and other fields. He is also taking over as head of India’s central bank. Rajan is no Austrian, but he has a quasi-Austrian take on the financial crisis, and far greater appreciation for free markets in general than any of the key US or European policymakers. As I tweeted this morning, Rajan is about 1,000,000 times better than either Summers or Yellen. I’d gladly trade him for any US central banker.

Consider, for example, Rajan’s take on the financial crisis:

The key then to understanding the recent crisis is to see why markets offered inordinate rewards for poor and risky decisions. Irrational exuberance played a part, but perhaps more important were the political forces distorting the markets. The tsunami of money directed by a US Congress, worried about growing income inequality, towards expanding low income housing, joined with the flood of foreign capital inflows to remove any discipline on home loans. And the willingness of the Fed to stay on hold until jobs came back, and indeed to infuse plentiful liquidity if ever the system got into trouble, eliminated any perceived cost to having an illiquid balance sheet.

As I wrote before, I’d reverse the order of emphasis — credit expansion first, housing policy second — but Rajan is right that government intervention gets the blame all around.

Rajan also wrote an interesting theoretical paper with Peter Diamond that echoes the Austrian theory of the business cycle: “[W]hen household needs for funds are high, interest rates will rise sharply, debtors will have to shut down illiquid projects, and in extremis, will face more damaging [bank] runs. Authorities may want to push down interest rates to maintain economic activity in the face of such illiquidity, but intervention may not always be feasible, and when feasible, could encourage banks to increase leverage or fund even more illiquid projects up front. This could make all parties worse off.”

Read the rest here

Having a free market proponent in the belly of the beast can both be a blessing or a curse. Although like Mr. Klein, one side of me wishes Mr. Rajan all the luck, another side of me tells me not to expect anything substantial.

While it may be true that Mr. Rajan has a magnificent track record of understanding central banks and the entwined interests of the banking system coming from the free market perspective, in my view, it is one thing to operate as an ‘outsider’, and another thing to operate as a political ‘insider’ in command of power.

Mr. Rajan will be dealing, not only conflicting interests of deeply entrenched political groups, but any potential radical free market reforms are likely to run in deep contradiction with the existing statutes or legal framework from which promotes the interests of the former.

Moreover, other political agencies, whose interests has been to promote the status quo, may run roughshod with Mr. Rajan perspective of reforms.

It would be interesting to see how Mr. Rajan will deal with  the present repressive “war on gold” policies by the Prime Minister’s Economic Advisory Council (PMEAC) whose interventionists actions has expanded to cover not only gold imports, but on gold transactions at every distribution level of the Indian economy.

In short, assuming the central bank governorship won’t just be about monetary, or banking policies but about the politics of bureaucracy, the welfare state and crony capitalism. 

Mr. Rajan will also have to deal with the huge resistance-to-change attitude from these groups.

In addition, in assuming the role of the proverbial hammer, where everything would look like a nail, the allure of the possession of the extraordinary power of political control over society risks overwhelming Mr. Rajan’s principles.

A great precedent would be former Fed Chair Alan Greenspan. Dr, Greenspan used to be an ardent Ayn Rand fan and a Ms. Rand influenced objectivist who embraced free market principles. Mr. Greenspan even authored the splendid, Gold and Economic Freedom in 1966. 

However upon assuming the Fed Chairmanship, Mr. Greenspan eventually abandoned free market principles to become a rabid inflationist or a serial bubble blower. Yet today’s lingering problems have, in effect, been a legacy of Greenspan-Bernanke actions.

True Mr. Rajan may not be Dr. Greenspan. But with the manifold challenging tasks ahead coming from different fronts, Mr. Rajan may want to take heed of Yoda’s advice to Anakin Skywalker: The fear of loss is a path to the dark side.