August 6, 2013 / 4:58 PM / 7 years ago

BREAKINGVIEWS - Fed could do with "Luddite" like Rajan

Chief economic adviser Raghuram Rajan speaks during an interview with Reuters in New Delhi March 11, 2013. REUTERS/B Mathur/Files

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

By Christopher Swann

NEW YORK (Reuters Breakingviews) - The U.S. Federal Reserve could do with a “Luddite” like Raghuram Rajan. Larry Summers, among the frontrunners for leading the Fed, said a 2005 speech by Rajan, then the International Monetary Fund’s chief economist, was based on a “slightly Luddite” premise: new-style finance increased the risk of crisis. Rajan may actually be more qualified than Summers to run the American central bank. But he’ll do the job for India.

The next Reserve Bank of India (RBI) chief is a leading member of the select group of economists who anticipated the 2008 financial crisis. Most of them, for example Nouriel Roubini, cast stones from the sidelines. To take a public stand while in a top official position, as Rajan did, took remarkable courage. Rajan has continued to be brave, although his often expressed doubts about the effectiveness of extreme monetary policy are no longer totally unconventional.

In retrospect, the 2005 speech might be Rajan’s greatest hour of glory. He gave it at a global central bankers’ conference celebrating the career of Alan Greenspan, a high priest of financial deregulation. Rajan was a party-pooper. He warned that securitisation had made the financial system more vulnerable, not safer. He questioned whether banks had sufficient liquidity to cope “if the tail risk does materialise.”

How right he was. And how wrong Summers was. The trademark brusqueness of the then president of Harvard University expressed the conventional pro-finance consensus.

Rajan’s prescience is a credit on the IMF, which has all too often been late to discover the limitations of its economic models. Even Simon Johnson, Rajan’s successor and now a leading critic of the finance industry, was confident enough in April 2007 to assure investors that “the financial tail” was not “about to wag the economic dog”.

President Barack Obama might take note. The Fed does not only manage monetary policy; it regulates the banking system. Summers has not shown much scepticism about the industry. Perhaps the next boss should have more of Rajan’s independent spirit.

Editing by Edward Hadas and Sarah Bailey

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