Raghuram Rajan & Gita Gopinath On Why Emerging Markets Like India Are More Resilient To Global Shock

Well, just on the independence, I think no set of laws can protect a central bank when society turns against it. I think this is Leche's point. Your independence comes from the constituencies who believe you perform a vital function, and it need not be the head of state, but it can be bond market players, it can be banks, it can be the broader public which likes a regime of low inflation, and you've convinced them that you're central to that aspect. So I think, to Gita's last point, part of your communication is to indicate that this is an important function, and you're trying to go beyond the set of analysts who follow you very carefully to the broader public and say, look, we are providing a function which is important. There is a reason we just don't reduce interest rates, because it can affect you in so many ways — through the currency, through longer-term inflation, etc. That communication has to be handled very carefully, because if you communicate too much, it's not just you confuse — politicians get angry: why are you interacting with their constituency? You are unelected. How come you can do this? If you communicate too little, you haven't built up the support which you absolutely need against the forces who want to go in the other direction.

I think when you look at it from the perspective of emerging markets, the movements in foreign exchange rates are much more sensitive to shocks than in industrial countries, and those movements can have feedback effects. In India, for example, everybody watches the dollar-rupee rate, not the real effective exchange rate or the nominal — it's the dollar-rupee rate. A lot of middle-class parents have their kids in the US; that affects the funding of those things. It becomes a very central sort of number, and so if that starts collapsing, questions are raised in parliament: why is the rupee depreciating so much against the dollar? And it becomes a source potentially of some kinds of panic. So broadly speaking, I think the Reserve Bank has focused on reducing volatility in that rate without, you know, saying this is the level that's very dangerous. You don't want to defend any level, but you want to reduce the speed of reaction to anything, and in that process you may build up reserves, you may sell reserves — it's not unidirectional. And the way you explain it to the global audience is: we're not targeting a rate. We don't use this as a competitive tool. This is more a precautionary tool to reduce the volatility, but also in the process sometimes to build up reserves so that we can have a way to reduce that fluctuation, given the world that we're in and given the numerous shocks that we have faced. And while we can all hope for a more predictable, less shock-prone world, I think it's a good idea to firm up your policy frameworks and your toolkits for a much more volatile world.