Raghuram Rajan calls upon EMs to build forex reserves

livemint.com:

Emerging-market authorities must take action to protect their economies against spillovers from “populist and extreme" macroeconomic policies in the industrialized world, former Reserve Bank of India (RBI) governor Raghuram Rajan said in an interview about his new book. This means building buffers like foreign-exchange reserves. Edited excerpts: Monetary policy is a blunt tool, as many have recognized.

With an active financial sector, it also becomes a tool with uncertain consequences, since the financial sector can react to extreme monetary-policy settings in unpredictable – and undesirable – ways. For example, a sustained policy of low interest rates engenders risk-taking and leveraging by the financial sector, leaving it exposed to losses when the policy setting changes. This has happened so many times that no one can claim to be surprised anymore.

Yet monetary authorities sometimes act as if someone else – bank management, regulators, supervisors – is responsible for dealing with the spillovers from their policies. A scapegoat is always found, allowing central bankers to avoid accountability. The US Federal Reserve’s Barr Report on the demise of Silicon Valley Bank is a case in point.

The report flags the usual suspects, beginning with the bank’s senior management. But there is no hint that Fed policy – for instance, quantitative easing and its subsequent rollback – might have contributed. This wasn’t even included in the terms of reference for the inquiry! Of course, there also are monetary-policy spillovers across borders, transmitted through capital flows.

In moderate doses, the cross-border flow of source-country money is good. But on a sustained basis, it can become problematic. The debate really is about how