Raghuram Rajan, a professor at the University of Chicago Booth School of Business and a former chief economist with the International Monetary Fund, has been sounding alarms about the dangers of ultra-loose monetary policy since the dark days of the global recession. The award-winning author of Fault Lines: How Hidden Fractures Still Threaten the World Economy, hasn't changed his mind, even as the recovery seems to be sputtering.
At this time last year, only a handful of central banks were tightening monetary policy. Today, most of them have shifted gears, but not the Federal Reserve.
If you want to ask why we are stuck in this low-interest-rate regime, in a sense the Fed has become a prisoner of expectations. If anything, people expect the Fed to do more magic tricks, pulling rabbits out of its hat, to try and lift the economy out again.
You argue that the costs of low interest rates outweigh the benefits, a view not shared by most mainstream economists.
The benefits of low rates are not huge and obvious. We haven't seen the intended channels [consumer credit growth, expanded business investment]work over the last two or three years. I'm saying the cost of low rates may be higher than we think, including costs to savers who are getting rock-bottom interest rates and are scrambling to find higher rates, perhaps by taking on more risk. They also may be cutting back on consumption, because their incomes are not keeping up. If you keep trying to energize those channels, you risk doing damage through other channels.
We have kept interest rates low across the world partly in response to the U.S. Fed's very low rates. As a result, activity in a number of emerging markets has been pretty strong. They've had extremely high rates of inflation, but also growth. And that has pushed up commodity prices. Of course, those commodity prices get reflected across the world, and come back to potentially hurt U.S. growth. The point I still want to make is we don't live on an island. The world is connected. And we have to worry about the unintended consequences of policy.
Besides high commodity prices, what other unintended consequences stem from low Fed rates?
I wish we knew all the unintended consequences. Unfortunately, we will know only five or six years down the line.
What about the effect on investments?
Take every pension fund, which has to meet a rate-of-return hurdle and which is now looking at getting abysmal rates in money markets. [The funds are]basically saying there is no way we can meet our pension obligations if we invest anything in money markets or in treasuries. Let's up the risk. That kind of behaviour, I would guess, is something that is hidden from us until it comes back and we see it for what it is.
One argument we hear for keeping rates very low is the damage higher levels would do to mortgage holders who are barely able to meet their payments now. You don't agree?
Many of the people who are on the edge are already in foreclosure. The benefits of low rates are obtained by those who can refinance, and those are typically people who could afford those mortgages. The people on the edge have no ability to refinance at this point. A lot of the late-period teaser rates went to people who needed rising house values to be able to afford the cost. They are in deep trouble right now, and the low rates aren't necessarily any help.
You predicted the financial crisis well in advance and have been right about the slow U.S. economic recovery so far. What's your current take?
I still don't think there will be a double-dip. I suspect that some of the forces we are seeing right now are temporary. The problem with a weak recovery is anything even temporary looks like we're being bludgeoned back into another recession. The temporary factors - the [Japanese]tsunami and the disruptions to supply chains - are having an effect ... on global growth, on export growth, even on production in, say, the car industry in the U.S. and Canada. These are temporary factors.