Transcription
Thanks very much. Uh, you might ask, what has global trade in crisis? What's next to do with financial instability and the financial system? Well, it's the "what's next." Okay. Um, uh, let me, uh, give you a sense of where I'm coming at this.
Um, we know the global order, which involved open trade and investment, has been weakening. Of course, uh, the current US administration is just the latest, uh, sort of blow to this, but it's also been weakening, uh, because of, uh, uh, for example, actions by China, uh, which, uh, in the past, have vitiated this, this order. We can talk about the details in the, in the discussion afterwards. But importantly, uh, it has been weakening because of domestic policy, uh, difficulties. We have never, whether in industrial countries or in emerging markets, paid attention to those who have been hurt by trade to a sufficient degree. We've always said, well, economists say global trade is good. Yes. But it also has winners and losers. And even though, on net, we think the winners have enough to compensate the, uh, losers, that compensation has never really taken place in an effective way, except in a few countries, uh, which are small open economies like the Scandinavian countries and perhaps Switzerland. But in many other countries, it hasn't taken place, and the, uh, sort of concern about the global order has, has increased from there.
At the same time, there's been a lot of anger about the global elite who manage, uh, economies. Um, certainly the global financial crisis, uh, created a lot of, uh, of concern that they didn't quite know what they were doing. And as a result, I think, uh, there's been a lot of questioning. When they say global trade is good, uh, when they say openness is good, do they really mean it, or is it self-serving? Are they protecting themselves because they benefit from the importation of goods and so on, but they're not subject to the kind of competition from global products that we ordinary people face? [snorts]
And of course, in this turmoil where the, uh, the current, uh, sort of economic system is being questioned, there's also the geopolitical risk that many of you talked about, which is, for the first time in, in a long time, we've had two hegemons who are competing for, uh, for turf. Uh, you know, this competition was never serious when the US was going against the Soviet Union. The Soviet Union was really an economic, even though it was a military superpower. H, it was never serious when the US was competing against Japan. Japan was economically much more, uh, much, much stronger, but, but, uh, was militarily dependent on the US for protection. For the first time, the US has a military and economic superpower to contend with, and, uh, there does seem to be a question of whether there's place in the world for both of them.
So, um, um, there's lots going on in the world. And of course, we've had a whole disruption of the, uh, global order, uh, by the US administration. Tariffs on, off, on. Uh, now there's some question whether the Supreme Court will say they should be, uh, rethought. But despite all this, there still is very little effect to be seen in the United States, uh, on either growth or inflation. You would be, you would think if there's so much policy uncertainty thrown against the economy, it would show up somewhere, and it still is, is not really showing up in a big way in either growth or inflation. Uh, some of this is because policy was anticipated, and so, uh, firms reacted, for example, getting ahead of the tariffs by importing goods. Inventories have built up quite a bit as a result. And, and also the consequences of pol, policy uncertainty, I postpone investment, well, that takes time to show up in the data, and, and maybe something to come.
But there's also been a lot else happening, even as we have all the trade uncertainty. There's been a huge investment, uh, in AI and AI-related sectors such as power. And that construction boom, equipment purchase boom has lifted a lot of ships. Uh, it's been huge in, in the sense of, uh, you know, at this point, it's, it's probably, uh, one and a half to 2% of GDP in terms of the, uh, increased investment that is visualized for next year. And, and that's, that's a big number. Um, so that's on the positive side.
On the labor market side in the US, we've had an immigration crackdown. Uh, which certainly has meant that whatever jobs are being created in the economy, they are, even though much lower than they used to be before, may be enough to absorb what is left of people looking, uh, of, of people coming into the labor force. So, in some sense, the labor market hasn't collapsed yet. That, uh, unemployment rates haven't gone up. That's because even as demand has come down, you've also shrunk supply, and as a result, there is a, a sort of tenuous balance there. Again, the operative word is "yet." We're starting to see some cracks in the labor market. We're starting to see more layoffs, and this is something that may, may become bigger over the course of the year.
And lastly, um, there's been a huge fiscal stimulus through the "big beautiful bill," which is going to show up in corporate balance sheets early next year, and that's something which is going to be on the positive. So, uh, certainly two positives, one negative, or, or, or, or one question mark in terms of other stuff that's happening, even as trade happens, which is why perhaps we haven't seen a lot, um, reflected in the data.
Of course, the government shutdown, uh, also increases uncertainty about the situation because we don't know what the real situation of the US economy is at this point. Uh, see if I can get this to. Okay.
Um, so there's a lot of uncertainty right now. But even as there's a lot of uncertainty, some of you are asking the question, why are financial markets celebrating? Stock prices are really very high. If you look at credit spreads, they are at a, a, uh, you know, a narrow, uh, certainly, uh, many-year narrow. And if you look at speculative assets like cryptocurrencies, they, or gold, very buoyant. Uh, and of course, there's a boom in mergers. It looks like everything is hunky-dory and the markets are celebrating.
Interestingly, the Fed always talks about conditions being restrictive, and that is a reason for the Fed to start cutting interest rates. But if you look at what, uh, uh, are sometimes called measures of financial conditions, taking everything into account, including, um, you know, spreads, uh, that are being charged, uh, to borrowers, including stock market levels and so on. If you look at a comprehensive measure of financial conditions, it hasn't tightened over the entire course of the Fed tightening. Financial markets in the US have been celebrating, and newer forms of credit, including private credit, have expanded hugely.
Um, you know, uh, you might have thought that the pandemic, which was a downturn, would have squeezed some of the excesses out of the system, but there was a huge amount of fiscal and monetary support during the pandemic. Very, very few businesses went bust during that time. So, it's not clear the pandemic squeezed out any of the excesses. And now, after that tightening, which didn't seem to have much effect, the Fed is starting to cut interest rates again. So the Fed is cutting into strong credit conditions.
Um, you know, what is the Fred, Fed worried about? It's worried about potential labor market weakness. Worried that it will get blamed for a downturn. Certainly being set up to be blamed for that. And also, there's a tremendous amount of government pressure on the Fed to think about cutting rates. So, in the face of all this, there is pressure on the central bank to cut, but it's not clear that, in fact, conditions are sufficient for it to cut.
So, what I'm going to do, given that the theme of the UBS center is to tell you a little bit about academic research, is tell you a little bit about what academic research tells us about monetary policy in these kinds of situations, and then conclude with some, uh, I will have to go fast, given the time we have, but let me try and get you, uh, uh, on board.
So, um, one paper, it, it helps to start with, is a paper done after the global financial crisis, which examines 154 business cycles in 14 countries. And what these authors do is look at business cycles that coincided with a financial crisis. And 35 of them coincided with the financial crisis. And they ask, well, what was, which crisis was worse and why? And they focus on excess credit, which is, uh, a measure looking at whether a particular crisis involved, uh, more credit to GDP than, uh, in the normal credit expansion. So, did you have more credit expansion, uh, before the crisis? And what are their findings? Not surprisingly, financial crisis-based recessions were worse. Okay, that's because the financial system also, uh, got into trouble at that time and wasn't able to fuel the expansion. But importantly, it was related to how much credit expansion took place before the crisis. The more the credit expansion before the crisis, the worse the downturn.
And this is the slide that makes it, uh, clear. Sorry, I, okay, it seems to be lagged. Uh, what you see in the dark line is the normal recession. The dark line basically says, normal recessions, uh, the economy goes down and recovers quickly. The dark line below that is a financial crisis recession. And what you see there is it goes down and stays down for a much longer period, and then comes back. And every dotted line below that is where the credit to GDP was higher and higher still. So, the worst crises are the ones where credit to GDP before the crisis grew really fast, and then things tank. So, too much credit is bad. That's the message you want to take away from this, especially if it results in the financial sector, um, uh, you know, falling into difficulty.
Now, let's, >> [snorts] >> uh, step back a second. Um, what does this have to do with monetary policy? Well, a whole bunch of studies after that went to look at monetary policy. Where did this credit come from? Was it in a situation where monetary policy was easier or tighter? It turns out, very interesting. Um, this is a paper by Grim et al., which basically says, let's take a measure of the stance of monetary policy as the real policy rate that's in effect, minus, uh, what might be the policy rate that would create an equilibrium in the economy. Let's call that the real neutral rate. So, the difference is when policy is tighter than what would be necessary for equilibrium, this would be positive. When policy is looser than what would be needed for equilibrium, this would be negative. Okay, so that's all you need to take away: tighter, looser than, than equilibrium.
And what did they find? They find again, uh, I need two minutes more because of lags in the slide. Uh, they find that one, uh, so on the left-hand chart, uh, what you have is the average stance of monetary policy before the crisis. Uh, and in the red line on the left-hand chart is what happened before the US, uh, before the global financial crisis. Uh, that's US policy before the global financial crisis. What you see is a U-shape. Why does the U-shape explain what happens? The first part of the U is when policy is being cut. Okay, that's when you're setting off the credit expansion which creates the underlying conditions for the problem. There's huge credit expansion, and then when you find that, oh, credit is expanding too much, you start tightening, and it's the tightening phase which causes the collapse. So, the U-shape is seen in real numbers, and what you see on the right-hand chart is credit expansion. Credit expansion is happening. It really takes off as the U-shape comes, the, you're going down, and then when you come up, it, it basically collapses the system because at some point, you need more and more credit to keep it going, and it makes the system, uh, uh, collapse.
Now, they've did it with real interest rates. Others have done it with nominal interest rates. Again and again, the U-shape starts showing up. It's the easy times when the problems are built up, and as you try and tighten because inflation has gotten too much, etc., the system starts backing up. Okay. H, this u, in the interest of time, I'll skip this slide. It's basically saying the same thing. Look at this in different ways, and, uh, what you find is easy money foretells with higher probability a crisis in the future. Okay. So, be careful about running money too easy because that, that creates potential problems.
Now, a classic example of this is the crisis, the global financial crisis, as it happened in Europe. Why is it a classic example? Because in the core countries, inflation was relatively low. We're talking about Germany, France, etc. Inflation was really low. So, ECB policy, when measured for the core countries, meant a relatively low, uh, a relatively moderate real interest rate. The policy was right for the countries at the core. But for countries at the periphery, Spain, Portugal, Ireland, where inflation was much higher at that time, it meant a negative real interest rate. Policy was too easy for countries at the periphery. Which were the countries that suffered a huge credit boom? The countries at the periphery. Which of were the countries that didn't? The countries at the core. Of course, the core banks, core country banks lend to the periphery, and so the crisis migrated to the core also. But the point here is that because the ECP was running a common policy, it was different for the core and the periphery and created very different impacts. And here again, you can see, uh, take just one example. I, I, I need to go get closer to read it. Take total credit. You see the periphery, which is the blue line, it goes up hugely. In the core, it doesn't. And that's because policy was much easier in the periphery, and we know they suffered the brunt of the crisis.
Now, of course, there's a real question, why do low interest rates, whether nominal or real, precipitate the kind of credit risk increase, the risk-taking that creates the problems down the line? Okay. Now, people have done, um, sort of research in the lab, uh, trying to show there is a behavioral component to this. Uh, for example, um, you know, when interest rates come down, uh, from a high, uh, uh, high, uh, risk-free interest rate to a low risk-free interest rate, when the central bank is cutting interest rates considerably, then at that point, it might look to households. This is, uh, work done by, by my colleague Yuran Ma and others. It might look at that point that interest rates have come down a lot. When interest rates have come down a lot, even though it's coming down because inflation has, has come down, etc., you might sort of get a little confused and say, I'm not getting the same kind of nominal interest rate that I was getting. I was getting 5%, now I'm getting just 1%, and you reach for yield in an attempt to increase the interest rate you're getting. Okay. So, you can find this kind of behavior, uh, in, in the lab when you, when you run it. It's also that when the interest rate is 5%, the additional spread you get from taking more risk, maybe a percentage or two, uh, percentage points of additional spread, doesn't look that big. 5% is large, 7% is a little larger, but it's not that much more. However, when the interest rate is cut to 1%, and you're still getting the 2% risk spread, you know, 3% looks a lot compared to 1%. And you stretch out on the risk spectrum. So, that's the point about salience.
Um, other arguments for why people take risk when interest rates are really low. For example, any institution which has fixed liabilities will then search for yield when its assets are generating low interest, uh, income. It's going to search for yield, and that's a common behavior. It's, it's a behavior we see even now. So, um, search for yield certainly is one way that this happens. Another is, um, you know, if, if at these times, money gets reallocated across the system, the entities getting a whole lot of, uh, money coming into theirs, especially banks, um, they don't know what to do with that kind of money which is coming into their coffers, and they typically end up making bad decisions. A classic example of this was in the, uh, 1980s, when we had a whole lot of banks getting, uh, petrodollars coming from, uh, the, um, uh, Arabian states coming into the big multinational banks, and what they did was they recycled it to Latin America, and those weren't great credit decisions. But you can see this in the microcosm also, preceding the global financial crisis, a bunch of banks saw an increase in deposits. What did they do with it? They couldn't lend it to their normal borrowers because those borrowers already had plenty of, of credit. So, they went out and searched for new borrowers, made those loans, and ended up making big mistakes.
Um, and there's also, in these times when everybody's making money, making loans, and earning the, uh, fees on those loans, there's a fear of missing out, right? Uh, remember Chuck Prince, the chairman of City Bank, just before the global financial crisis, when asked, you know, aren't you worried about the risks? He said, "Well, the music's still playing, and so we have to dance, right?" Uh, many years later, I met him at a conference, and I asked him, "So, why did you say that? You, you have the most, um, sort of, um, memorable quote from the crisis, and not in a good way." Um, and, and he said, "Look, the real problem was that, uh, nobody knew when the party was going to end. But if I had called it, uh, and told my M&A people, you can't get any more credit at this point. You can't, it's just too risky. They'd have walked across the door, uh, uh, uh, uh, they would have walked out of the door to my competitor and joined their M&A group, and they would have been very happy to hire them because everything was red-hot. And so I had the choice of either saying, I know this is going to come to an end. Let's stop now. Or the music's playing, and let's continue. Because if I called it a stop, I'd have lost a chunk of my staff." Seems plausible, but it is an issue that, uh, that one has to worry about.
Let me, um, uh, thus far, I've been talking about interest rates, but what is important is also to understand that today, uh, central banks don't just play with interest rates, they also play with liquidity because they can expand their balance sheet and put out reserves. Reserves are the most liquid asset on the planet. So, they're increasing liquidity in the financial markets when they do that, and they, when they shrink it, they're reducing liquidity in financial markets. And central banks have been doing the expansion, what is called quantitative easing, and shrinking over the last few years, and some people think this is a free extra instrument. I would say it also contributes to the same kind of risk-taking phenomenon.
Um, it is used to stabilize financial markets and also used when central banks run out of interest rate policy because they hit the lower bound. But it has consequences that they have not anticipated. One of the consequences is, as they flood the financial markets with liquidity, it turns out you haven't reduced the frequency of liquidity shock episodes. In fact, they seem to have increased, which seems strange. You're flooding the market with this really liquid asset, but you have the opposite consequence. Uh, September 2019, the US markets backed up. March 2020, they backed up. March 2023, they backed up. April 2025, they backed up. And October 2025, they backed up again, which is why the US has stopped quantitative tightening. It says, you know, the market needs ample reserves, and let's stop now.
Interestingly, uh, when the US, uh, Fed started expanding its balance sheet in 2008, the size of reserves was 80 billion. When they stopped, uh, quantitative easing, um, um, it was about 1.7 trillion, and then they brought it down to about 1.4, 4 trillion, and they had to start it up again in September 2019 because the system was backing up. Okay. Then they expanded it hugely, and recently they started reducing the size of the balance sheet, but they've stopped. What is the size of reserves now? 3 trillion. So, from 80 billion, it's gone to 3 trillion. 3 trillion is now considered enough for the system. Why does the system require so much? Because liquidity is like a drug. The more you get of it, the more you want. And what do I mean by that? It means that, um, you know, when the central bank expands its reserves, banks have to hold it. It's costly for banks to hold reserves because they're low-yielding assets. So, they try and use them. What does it mean to use them? Basically, first, you issue short-term liabilities rather than long-term liabilities because short-term liabilities are safer when you've got a lot of reserves to protect you. So, banks have moved more to demand deposits to finance the reserves. They also go to firms and say, "You want liquidity? I will write you a line of credit. When you need the liquidity, I'll be there to give it to you." So, lines of credit have also expanded hugely, written to firms, and banks have also increased their funding of speculation. The kind of leverage that is implicit now in speculative bets like the covered, uh, u, uh, the, um, um, um, what they're doing in the bond basis trade. The kind of leverage that's there is the kind of leverage you had before the global financial crisis in banks. Huge, 50 to 1, 100 to 1 leverage there.
So, what's happening is all this liquidity is being used by the banks to provide liquidity to the system, which means when the Fed withdraws liquidity, the system says, "Hey, don't withdraw too much because we've used up all that you provided." And that's why 80 billion dollars of reserves was enough in 2008, 1.4, 4 trillion in 2019, 3 trillion now. It keeps going up.
So, what's the worry? Well, the worry is each, uh, of these, um, uh, basically, if the central bank expands reserves, let's see, okay. When the central bank expands reserves, the supply that it creates creates its own demand and basically makes it much harder for the Fed to pull back. But the system really becomes extended, and when there's plenty of liquidity in the system, every asset price moves up, every credit spread narrows, and leverage moves up in the system.
So, what's to worry now? Basically, one worry is that, you know, the system is getting stretched, and when the system starts imploding, bad things happen because you get financial sector entities getting into trouble. And, you know, to some extent, we've become really reliant on the central banks. Uh, the Fed has always said it will help the system out when the system gets into trouble, and it has done that most recently in 2023, when the Silicon Valley Bank got into trouble, with, you know, cutting interest rates if possible, with special facilities if possible, with additional liquidity. The problem, however, is when the Fed keeps doing this, it makes the problem worse because the system knows the Fed will come in. Okay, the system knows the Fed will come in, and it undermines discipline in the Fed.
So, with, uh, uh, with that, the question is, you know, how do you, how do you reduce that problem? How do you make sure that when the Fed comes in to help the system, it actually does the right thing? Well, there's a famous, um, book by Walter Bagehot, who used to be the editor of The Economist, and he had a famous line in that book, which is basically, when the central bank comes in to bail out the system, it should lend freely against good collateral. So, should lend to solvent entities against strong collateral that they have, but at a high price. Okay, that high price was very important. Well, what we've done with the central bank's intervention is always, we've lent freely, sometimes against good collateral. In the last lending spree, when the Fed intervened after Silicon Valley Bank, it wasn't against the full value of collateral. But what is important is it's never charged a high price. If you do theoretical models, the high price it should charge is the price the private sector would charge. That's the price that keeps the financial system honest. But politically, it's very difficult for the Fed to charge that high price when it intervenes. So, it always intervenes at a really low price, after which the banks say, "You didn't help us. We just got out of this on our own. Uh, where was the help?" It turns out that if the Fed really wanted to keep them on the straight and narrow, it should charge a really, really high price.
So, uh, that hard, high price is hard to charge, whether you charge it exposed when you intervene because the banks are in trouble, then you don't want to charge that high price. It's hard to charge ex ante when you provide insurance. Whenever the Federal Deposit Insurance builds up equity, builds up profits, the banks always saying, "You're charging too high a premium, reduce those premiums." The point is, it's very, very hard for the public sector to charge a high price. And so the net effect, and I'm going to, uh, go to the last slide now. The net effect is, uh, is that, you know, central bank intervention, because it's always done at too low a price, uh, turbocharges the effects of accommodative policy. And people have studied this across central bank interventions over time, and not surprisingly, central bank interventions help avoid the current crisis, but always create a higher probability of a future crisis because the private sector then comes to see the, the central bank as a support.
So, uh, let me, uh, conclude because I'm really out of time. If I can get to the last slide. Uh, okay. So, we can't afford another crisis. That's not surprising. But it's also something we can't afford because the kind of fiscal space governments have is not what it was before the global financial crisis or before the pandemic. Today, most industrial countries are at 100% of GDP, uh, debt to GDP, and some much more. So, in this kind of situation, you don't have the kind of government, uh, fiscal space to back the central bank if it intervenes in a big way and takes on a variety of credit risks and so on.
So, while the central bank should try and prevent risks from building up by using macroprudential tools to prevent, uh, uh, banks, for example, from taking that risk, that may not be sufficient. Macroprudential risks may be weak if, at the same time, you're pushing on the monetary policy accelerator. So, in a sense, you should take into account overheating, credit expansion, etc., when also doing the monetary policy setting, if your macroprudential tools are not enough.
What does this mean for today? And that's my last point. Today, we are in a situation where credit is starting to build up. Asset prices are high. Yes, maybe the labor market is somewhat weak, but there's immense investment going on from the side of AI, etc. At this point, for the Fed to contemplate cutting more and more in interest rates is getting us back to that point of the U-shape, where the U-shape, the first phase of the U, where you're cutting interest rates, sets in play the kind of credit risks that come back to bear when you start raising interest rates. We haven't dealt with inflation yet. We are cutting interest rates. Perhaps we also should be worried about the financial system and the risks it's taking, even as we deal with everything else that's happening in the real system.
Let me stop there. Thank you. [applause] Mr. Rajan. Thank you so much for this. This is a pretty ominous warning that you're giving us. Also, your questions, ladies and gents, of course, are welcome. And I see that some of you have already written in. But let me just start, if, if I may, because you said the credit, um, extension is, is going on. It's increasing. But what's different this time, many of us would argue, is that it's happening when it comes to the private markets, private credit, not necessarily banks' balance sheets. Does that make it even more dangerous because the Fed is toothless here? What's, what's your sense here?
>> Uh, it's a great point. Um, yes, private credit has been expanding. Some say it's, it's partly regulatory arbitrage. The big banks, because of capital requirements, etc., find it actually easier to lend to the private credit suppliers, and they then on-lend to the, uh, uh, to the final borrowers. And so, it's not that the banking system is, is immune from this. It's fully engaged, but you're not seeing, uh, you know, the next stage, which is, uh, regulators don't regulate the private credit entities, and the quality of that is certainly an ongoing issue. We've already seen some concerns, but I would say that the issue is not today. The issue is what happens in the next couple of years with, on the one hand, we've, we've sort of, in a sense, got a combination of 2001 and 2008. 2001 because of the frenzy of the internet. Now we have the frenzy over AI, and 2008 because of, of potential credit, uh, ballooning out, and they come together in the sense that today, many of the super-scalar AI companies, uh, they used to finance a lot of their AI investment from internal sources, from the immense profits they're making. Now they're going out and they're saying, "We're going to outsource this. We're going to create special purpose vehicles, etc." All that is going to be dependent on AI demand, which is a big unknown. How much, when, uh, is it going to be in the right places? Those are all questions that need to be answered for us to feel comfortable about this kind of lending that is starting to take off now. So, I, I think it's early days, but it's, it's the time we should exercise caution.
>> In other words, you're saying, just to invoke the quote from Prince Chuck again, the music is still playing. We don't know when it stops. Remember back in 2005 in Jackson Hole, you presented a paper on the risks to financial stability. I, I don't think anyone wanted to listen to you back then, and that was a couple of years before the crisis actually hit. Are we a couple of years out? At which point are we right now? And what should the Fed, in an ideal setting, without political pressure, what should it be doing? Should it stay put, or should it even hike?
Well, even when you trade off inflation versus growth, it doesn't have enough evidence growth is falling through the floor. Even now, as I said, AI investment is huge. And even if you look at consumption, upper-middle-class consumption is quite strong in the United States. Lower-middle-class is falling off. Uh, they're, uh, people who are hurting, but by and large, the economy is still being supported on both consumption and investment. Uh, they're concentrated. They're not spread through the economy, but overall growth is pretty strong, which is why, you know, inflation is 3% by most counts. Last few months, because of the trade effects, it's gone up to nearly four. It probably will stay in the upper levels of four, uh, or mid-levels of four until, until mid-next year. That's, that's what people are, are, uh, contemplating seeing the pass-through of goods prices into inflation. For the Fed to be cutting under in that environment, yes, I understand the, um, the insurance cut, but the insurance cut is one, maybe two, not an extrapolation of cuts. And so, in the absence of more data, I would say it's particularly dangerous to keep cutting, especially when financial markets are so exuberant.
>> But again, that's where the political pressure comes in, and of course, we know J. Powell will be replaced next May. Uh, final question for me, because what's happening in the US, and you repeatedly say that the US growth is not falling off a cliff, but what we're seeing is a very peculiar K-shaped, uh, progression. The higher earners, they're doing pretty well, but the lower earners, they're, they're not, obviously, they're suffering. So, what Trump is delivering to them, the people who voted him into office, >> is not a rejuvenation of the industrial basis. What he's delivering is an AI boom, >> pull out AI boom. But he's not delivering for his key voters, is he?
>> He's not, because in parts. So, yes, some, uh, factories that were GM factories that were in Canada will come back to the US. That's the old-style, uh, autoworker job. But of course, even those jobs have been highly automated. So now it's more looking after the machine rather than doing the work instead of the machine. Right? So, that's, that's what's happening on the, uh, on the job front. But, uh, I mean, where he has delivered is on immigration. So, he, he certainly has cut down on immigration hugely, uh, through measures that you may or may not agree with. But that's, that's certainly cut down immigration. But this, in fact, is creating scarcity in some areas, construction, for example, where, in fact, you know, you're, you're sort of hurting overall growth, uh, in, in the economy. It is, however, in the longer run, um, some of those jobs will become higher paying as a result of the scarcity of workers, and that may help some of the moderately skilled, uh, workers who are his base. But in the short run, are we seeing a huge growth in, in jobs at that level? No. These are people who are hurting even more because of the fact that, you know, the tariffs, for example, are creating more inflation and eating into their disposable income. So, one of the messages from this recent election was, you know, you haven't fixed inflation, which you said you would.
>> Absolutely. Let's get to some audience questions. Um, many of them here, um, the audience can actually vote on the question that they like most. Um, one of them being, can developing countries still count on global trade as an engine of growth, or has that window closed? What do you think?
>> Well, Ralph was telling me [snorts], which I thought was very, very, um, important. Ralph Osa, is that, uh, 75% of trade still goes on as before. The fact that a 15% beh is putting all...
>> Don't spill the beans. That's the next panel. [laughter]
>> Yeah, that's why I didn't talk about trade at all. He's going to talk about it. Uh, but that gives you some hope that if the rest of the world, sort of, talks now, there is a one, one caveat, which is that if China, which was exporting to the US, finds that not only the direct exports are affected, but also the transshipments. Now, that's a huge issue because it's, China hasn't reduced its exports, it seems to be exporting through, uh, some of the emerging markets and developing countries to the US. If the US cracks down on that, then where do Chinese exports go? They have to find a place in the rest of the world, and then the rest of the world starts reacting to that. That may make global trade much more fraught than with just the US reacting. But let's, let's say the US can't stop those transshipments. Then maybe all we've done is reconfigured global trade a little bit, but much of it goes on as before. What I find particularly, um, interesting is that the US has done everything it's done without the rest of the world, sort of, forming any kind of coalition to say, "Look, this is bad, and we should resist this," and, and maybe together. But it seems like the divisions in the rest of the world make it very hard for them to come together. I think in the longer run, there will be these, these, uh, you know, new groups that form, new kinds of trade agreements that form, etc. I think it will still be, uh, you know, less good than having a single, single trade. But, uh, bottom line, I don't think the developing countries are going to, you know, it's going to be, uh, devastating. It'll be bad, but that comes on top of a pandemic, which was really bad for them. We'll debate in the, during the next panel as well.
How important is it for central banks to act independently from executive government interference? I assume you'll say extremely important. Can I just ask you about your experience as the governor of the RBI, because you were under some political pressure as well to keep rates relatively low, I assume. So, there's always pressure on you to cut rates, and, uh, unlike so, my whole effort during my governorship was to create an inflation-targeting committee, because it's harder to pressurize a committee than to pressurize one guy. I was the guy who determined interest rates. Does that work?
>> Uh, we did, we did form a committee, and India's inflation has stayed within the band for the, you know, whether it was the committee which did it, it was a success. Um, but, you know, my, uh, u, sort of, uh, role was to hear them and then to tell them why it couldn't be done. Uh, because the argument was always, "You have to cut interest rates." But importantly, they knew that if inflation took off, they'd sort of have to bear the brunt of that. So, they put the pressure on you, but you could tell them no. When you said yes, it was because you thought inflation was manageable, and, and so they were willing to give you that freedom. You decide, "We're going to keep pressuring you. We're going to keep telling you not, not the way the US president is pressuring Chair Powell, but certainly in private, you know, why aren't you doing it? Why aren't you doing it? All my business friends are telling me that interest rates are too high. How come you academics think you know enough that you're not doing it?" I mean, all the usual arguments, and you're saying, "Look, wait, be patient. I will cut when the time comes." And, and, and you did it. I mean, you, but, um, you have to stand up to pressure. Well, fortunately, I had a job in academia also. So, uh, I could always think, "Well, if I get fired, I can always go back to academia." And, uh, and call that a perfect...
>> That gives you backbone. That gives you backbone. Uh, but you have to have backbone. It is a job with enormous pressure.
>> And of course, a former central banker is in the room and he will know about that pressure and, uh, in terms of standing up to that. He's still getting important calls. No, that's not your phone. [laughter] Let's get some audience questions in. Okay. Yeah. So, [clears throat] uh, you highlighted the dangers of loose financial conditions and you emphasized the political economy constraints that come from the sector itself, the financial sector lobbying for lower rates. I was wondering whether you had any thoughts on another source of lobbying in the same direction, which is governments, which I think now, given the level of indebtedness, are basically hoping for inflation, which is going to get them out of the corner where primary surpluses will never help. Um, is that an underappreciated dimension of the buildup of loose conditions that we see?
>> Um, I think it's underway right now. Um, I can think of at least one central bank which, well, let me not mince words. I think the Bank of Japan, with debt to GDP as high as it is, Japan benefits from higher inflation than normal, uh, if it's unexpected, because that reduces the size of the debt burden that they have. And I'm not saying this is what the Bank of Japan is doing, but after a huge period of low inflation, uh, they've been resisting the notion that inflation is now finally here to stay. And, you know, incidentally, it's been very helpful for bringing down Japanese debt. Um, you know, how much of this is, I, I, I, I don't think it's so much government pressure as the central bank trying to, you know, work things out so that it doesn't, um, sort of act too soon, uh, in an environment which is actually favorable for macro stability because it's reducing the size, uh, the real value of the government debt. Uh, that said, there's a danger of letting inflation get too high because then you have to really increase real interest rates to the point where that's the killer. Real interest rates which are very high would make high levels of government debt really unaffordable, and you won't, don't want to get to that point. So, there's a balancing act. But the point is, as soon as you start considering government debt in your equation, you have what is called fiscal dominance. It's not just growth and inflation that you're thinking about, but you're also thinking about government debt. And that makes monetary policy even harder to set, let alone thinking about the financial sector, which I'm adding as yet another part of the equation.
I, in your first or second slide, where you did the analysis of the situation as it is, you mentioned about instead of one, we have two hegemons. Uh, both of them are not feeling happy on the basis of two is a company, three is a crowd. But do you think now more than two, more the merrier will be much better for global trade instead of two, if we have four, for example?
Um, I think, uh, I mean, we, we have to, uh, deal with the fact that the two are much bigger than the rest, except for the EU, which is, is less well-coordinated than, than the two separate countries, both of whom seem to be under, uh, fairly robust or authoritarian leaders. Um, uh, I think what would be an important message for China to hear from the United States is, "We are not here to undermine your growth. We are happy for you to grow, even if you overtake us. We just don't want you, we want you to follow the rules of the game." That message, uh, is something that, you know, perhaps would be great for China to hear, and, uh, it would be great for the US to hear that God didn't give you the single right to be the largest economy in the world forever. At some point, other countries are going to overtake you, but that's okay, because you have so many, uh, sort of strengths which are going to still keep you one of the richest countries in the world for a long, long time. But, you know, so what if some other country becomes bigger and, maybe even militarily more powerful? Each, hgeimon has to get used to the other one being comparable. And unfortunately, neither is used to that. Uh, and that's where the fight comes, right? Uh, China thinks the US is, is completely broken as a system and sees its opportunity. And the US thinks China is, is not behaving by the rules and [snorts] wants to, wants to therefore use every means it can to keep the other under. Uh, how do you get a bipolar world? Probably that, that word doesn't, how do you get a bipolar stable world? And that has, that requires acceptance on both sides of each other's relevance and importance. Right now, it is, "I'm going to try and keep the other from, from, from exercising any influence," and that's not going to work.
>> And another audience question ties into this. Where does India fit into all of this?
>> India's is relatively small. It's at this point a four, uh, four and a quarter trillion economy. Uh, about the size of Japan, uh, probably overtake both Japan and Germany in the next year or two. Uh, so, as a country, it is big, but relative to the two hegemons, it's still quite small. Um, I think the hope that Indians have is this 6% growth that it has right now goes to eight with the right sort of environment, and it catches up eventually to the two hegemons and becomes, uh, the third. But, you know, any kind of calculation you do with those kinds of growth rates means it's going to be 15, 20, 30 years before that happens. So, I think it takes time for India to get really big. But can it be ignored? Probably not. Of, in, in the next three or four years, it becomes an important source of global growth, which is why India needs to do all the right things, including on the environment, that it has to become a more, uh, you know, environmentally sensitive growth, which is what, is it's trying to do, is happening in some ways.
>> Obviously, Mr. Rajan, we'll be talking about tariffs in the next two sessions. And the Swiss got a pretty bad deal. I don't know if you remember, August 1st, 39%. Now, there's one country that got an even worse deal, India, 50%.
>> But I hear that things are moving. First of all, I don't know if that should make this list feel any better, but someone else is. But things are moving, right? Because you're buying less oil from Russia. Is, is that the way to please Mr. Trump? So, I don't think Russian oil purchases were ever the central issue. I mean, you just saw yesterday he waved the purchase of oil by Orban in Hungary. Uh, that's okay. I, I don't think that was the central issue. I think the central issue was more personalities and, uh, especially a personality in the White House and how they treated certain comments, uh, made by India after, uh, you know, um, Mr. Trump claimed credit for stopping a conflict between India and Pakistan. Pakistan played it the right way. Said that it was all because of Mr. Trump. India tried to argue that the two countries had reached an agreement without Mr. Trump. Uh, the truth is probably somewhere in between. But, you know, uh, net effect was India got 50% tariffs, Pakistan got 19. Uh, I understand that, uh, there was some comment about how, uh, your leader in Switzerland tried to explain the tariffs to Mr. Trump, and that didn't go well.
>> Uh, so,
>> We don't know what really happened. Conflicting reports here. Yeah, we, we don't know what happened between India and, and, and the US, but hopefully, hopefully, the longer run sanity prevails on all sides, and we all reach reasonable deals. There's no reason for either Switzerland or India to be out on a limb with higher tariffs.
>> You're absolutely right, Mr. Rajan. You saw there were so many more questions. We're out of time. I don't know if you have time to stick around for coffee. Um, please do approach him. Thank you so much. I really appreciate it. And we'll take a 30-minute coffee break. We'll be back with the next panel on global trade and what happens thereafter. Next. [applause]
>> Thank you.