Former Indian Governor Raghuram Rajan highlighted the rigid line that policymakers must pursue with monetary stimulus and warned that a false move could lead to a global “wealth shock” that could scare consumers.
With the cost of living rising higher in many regions around the world, central banks would usually hit back on their bond purchases and push up interest rates to curb inflation.
The US Federal Reserve has begun to normalize policy following its economic downturn coronavirus pandemic. It said last week that bond purchases would begin to decline “later this month” and acknowledged that price increases had been faster and more lasting than central banks had anticipated.
Rajan, who headed India’s Reserve Bank of India between 2013 and 2016, said that this accommodating policy from many central banks had caused bubble-like conditions in some assets, adding that he believed inflation had now become “more than transient”.
“One of the problems of course … if the central banks move too fast, the markets adapt too fast then you have a huge wealth shock in the economy and that scares consumers and so on, and you can trigger the recession that you did not want in the first place” , he told CNBC’s Julianna Tatelbaum on Wednesday from the UBS Euro Conference.
He added that central banks must proceed cautiously, but warned that decision-makers would not do anything at all.
“The longer they wait [to normalize policy] the more this type of feeds on itself and there is a belief that central banks will not move, interest rates will remain low for a long time, says Rajan.
“Worst of all is that the markets think that the central banks have their backs. If things collapse, they will come back again with a really accommodating policy, and if that is the case, the central banks are in a way trapped by the markets.”
Last week, the Fed voted not to raise interest rates from its anchor near zero, and warned against expecting imminent rate hikes. However, the US Federal Reserve did not back down from using the controversial word “transient” in relation to inflation.
– CNBC’s Jeff Cox contributed to this article.