Raghuram Rajan rules out picking unconventional tools to tame inflation

Known for his strong monetarist approach and hawkish view on inflation, Reserve Bank Governor Raghuram Rajan today defended the rate hikes earlier this week and ruled out adopting any unconventional tools to tackle price rise.

At a Town Hall meeting with school students here this morning, Rajan when asked whether he would be more innovative in combating inflation or will stick to tools adopted by his predecessors of raising interest rates, said he does not have any wonder tool to fight the price rise menace. "Do we have any new or wonderful tool (for inflation) or can we invent one? I think problems emerge when central bankers get overly innovative in the tools that they will use. So, I think its better to be a little boring and to do what is conventional because conventional works. If you try the unconventional you may create a whole set of new problems," told the meeting organised by the 'Newspaper In Education', a children's publication from the Times Group.

"One reason for high inflation is supply-side mismatches and other is too much demand. Now, there are many ways of constraining demand. Less spending by the government is a way of constraining demand. Another way is to make demand match supply, which is to raise interest rates," Rajan said.

He, however, was quick to added that to accelerate growth, the central bank is taking newer steps. "We are trying our best to improve health of the economy and we will do whatever it takes to improve that. As far as growth goes we are addressing it through a variety of reforms which make finance easier and more widely available but I hope the answer for us in the demand-side is doing something different from what we are doing now," he said.

He further said as far as the current situation in the economy goes we have both supply-side problem -- large projects have been stalled, and also on the food side there are discrepancies in distribution. The Governor who took over charge last September has raised interest rates by 75 basis points in three out of his four monetary policy announcements, citing elevated inflation as a major cause of concern. 

When asked what the central bank is trying to achieve with the recent hikes in key lending rates, Rajan said it is to keep cost of money higher and manage inflation expectations. "Can hike in repo rate have some effect (on inflation)? It works in two ways: one, as inflation comes down by keeping the cost of money higher, I think repo rate has an effect. And, second is by setting inflation expectations," Rajan said.

"A lot of what central bank does is managing expectations. If I tell you that I intent on keeping inflation contained and I will do what it takes to keep inflation contained, eventually people start to believe it." Rajan further said once people start believing that a central bank is keeping inflation contained, they determine the prices, whether selling now or later, which will moderate prices.
"So, inflation management is partly about expectations, partly about doing things that affect the real cost of money, and I think we are trying to do both," the Governor concluded. 

When a student asked when our monetary policy will determine the course of the world economy, as the US does now, he said, the ideal situation is the one under which every major country takes into account the impact of its actions on other countries. "I have been saying that the US should worry about the effects of its policies on the rest of the world. So if I stood by that, we should not be happy down the line when our policies affect the rest of the world adversely. We would like the world where countries take into the account the effects of their polices on other countries and do what is right rather than what is just right given the circumstances of their country." 

He concluded by saying that "as we get bigger we will be significant force in the world economy."