War of Ideas
The Raghuram Rajan FP Reading List
Raghuram Rajan, a former IMF chief economist and former University of Chicago professor, has just been tapped to head the Reserve Bank of India. Rajan has been on FP‘s radar for quite some time. Under the then-more-culturally-relevant headline "Rajan Against the Machine," FP speculated in 2003, shortly after he was hired at the IMF, that ...
Raghuram Rajan, a former IMF chief economist and former University of Chicago professor, has just been tapped to head the Reserve Bank of India.
Rajan has been on FP‘s radar for quite some time. Under the then-more-culturally-relevant headline "Rajan Against the Machine," FP speculated in 2003, shortly after he was hired at the IMF, that "the fund [might] have unwittingly hired its own Joseph Stiglitz, the former World Bank chief economist who became a fierce critic of the free-market orthodoxy of both his institution and the IMF."
It didn’t quite turn out that way. Rajan is still very much a Chicago-style economist, though he has been willing to challenge orthodoxy at times. He is probably best known internationally for his prescience on the global financial crisis: He was pilloried at a high-level economics conference in 2005 for giving a presentation titled "Has Financial Development Made the World Riskier?" in which he argued that incentives in the financial system had become badly skewed.
In a 2008 FP interview, he discussed whether the crisis had altered his free market beliefs:
We’re not fundamentalists who think that markets exist without any intervention. We understand there’s a solid bedrock of government regulation that is needed to make a free market work. The mistake some people on the extreme right make is that they think that’s not needed. It is needed, but we say also that when regulation fails and the market sort of creates its own crisis, that becomes the opportunity for those who are anti-market and anti-competition to come in with a host of proposals to essentially defeat the market and to shackle it in the future.
And that’s really my fear about this particular crisis. The more government intervention there is to bail out the system without private-sector participation, the more the public opinion will be, This is a one-way street. They feast in good times, and theyre bailed out in bad times. And the results will be to the financial sector’s own detriment because the public will want overregulation rather than underregulation.
In 2010, he discussed the risk of contagion from Greece’s financial crisis with FP‘s David Kenner:
Essentially, you move from a situation where these guys had the implicit support of the EU to where they’re all on their own bottoms. Then the market will have to look at each of these markets individually and ask if we can trust them to repay.
Of course, the countries that are individually fine should be OK, and the countries that are at the center of the euro area, where there is still some solidarity, may still be OK, but the countries that are at the periphery will be more problematic. Maybe this goes on to Portugal. Probably not to Spain, but it’s not unthinkable — Spain has a huge level of unemployment, and while its government debt is still relatively low, the potential for it to rise is substantial.
[If Krugman] denies a role for government housing policies or for monetary policy, or even warped banker incentives, then to what does Krugman attribute the crisis? His answer is over-saving foreigners. In short, countries with trade surpluses, such as Germany and China, had to reinvest their resulting financial windfalls in the United States, pushing down U.S. long-term interest rates in the process, and igniting a housing bubble that eventually burst and led to the financial panic. But this is only a partial explanation, as I argue in my book. The United States did not have to run a large trade deficit and absorb the capital inflows — the claim that it did sounds very much like that of the over-indulgent and over-indebted rake who blames his creditors for being willing to finance him. U.S. policies encouraged over-consumption and over-borrowing, and unless we understand where these policies came from, we have no hope of addressing the causes of this crisis. Unfortunately, these are the policies that Krugman wants to push again. This is precisely why we have to understand the history of how we got here, and why Krugman wants nothing to do with that enterprise.
Although I believe that the basic ideas of the free-enterprise system are sound, the fault lines that precipitated the crisis are indeed systemic. They stem from more than just specific personalities or institutions. A much wider cast of characters share responsibility for the crisis: it includes domestic politicians, foreign governments, economists like me, and people like you. Furthermore, what enveloped all of us was not some sort of collective hysteria or mania. Somewhat frighteningly, each one of us did what was sensible given the incentives we faced. Despite mounting evidence that things were going wrong, all of us clung to the hope that things would work out fine, for our interests lay in that outcome. Collectively, however, our actions took the world’s economy to the brink of disaster, and they could do so again unless we recognize what went wrong and take the steps needed to correct it.