It was a pleasure to welcome Raghuram Rajan back to the Alpha Exchange. Raghu is currently a distinguished professor at the Chicago Booth School of Business and is the former head of the Reserve Bank of India. With a deep understanding of the intersection of markets, the economy and policymaking, he is among the most important voices on Central Banking.
With this in mind, our discussion explores his recent book “Monetary Policy and Its Unintended Consequences”, the title alone of which is entirely through provoking. Raghu shares his assessment of the tendency for policy towards increasing asymmetry – where the Fed acts as a lender of last resort during a crisis but finds itself unable to achieve normalization during non-stress periods. We talk as well about the distortions that result from forward guidance and asset purchase programs during non-emergency periods.
Lastly, we talk about policy spill-overs, specifically the impact that the Fed’s actions can have on emerging economies. As head of the RBI a decade ago and as India experienced the impact of Bernanke’s 2013 taper tantrum, Raghu has much to say on this subset of unintended consequences. He argues that the Fed’s remit will continue to target domestic growth and inflation, consideration of the international impact of policy decisions should conceivably be a part of the policymaking conversation.
The second half of our discussion focused on Raghu’s most recent book, “Breaking the Mold”, in which he reviews the progress and challenges in India. Here, he documents the diverging paths of India and China and makes recommendations for how India can learn from what China has done while recognizing both the constraints and opportunities associated with today’s global economy. He argues that India is uniquely positioned to provide high value-added services in a digital and remote work economy.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Raghuram Rajan.
[00:00:00] Hello, this is Dean Curnutt and welcome to the Alpha Exchange where we explore topics
[00:00:07] in financial markets associated with managing risk, generating return, and the deployment
[00:00:12] of capital in the alternative investment industry.
[00:00:15] It was a pleasure to welcome Raghuram Rajan back to the Alpha Exchange.
[00:00:24] Raghu is currently a distinguished professor at the Chicago Booth School of Business
[00:00:28] and the former head of the Reserve Bank of India.
[00:00:31] With a deep understanding of the intersection of markets, the economy, and policy making,
[00:00:35] he is among the most important voices on central banking.
[00:00:38] With this in mind, our discussion explores his recent book, Monetary Policy and its
[00:00:43] Unintended Consequences, the title alone of which is entirely thought-provoking.
[00:00:47] Raghu shares his assessment of the tendency for policy towards increasing asymmetry where
[00:00:52] the Fed acts as a lender of last resort during a crisis but finds itself unable
[00:00:57] to achieve normalization during the non-stress periods.
[00:01:00] We talk as well about the distortions that result from forward guidance and asset purchase
[00:01:04] programs during non-emergency periods.
[00:01:06] Lastly, we talk about policy spillovers, specifically the impact that the Fed's
[00:01:10] actions can have on emerging economies.
[00:01:13] As head of the RBI a decade ago and as India experienced the impact of Bernanke's
[00:01:17] 2013 taper tantrum, Raghu has much to say on this subset of unintended consequences.
[00:01:23] He argues that the Fed's remit will continue to target domestic growth and inflation
[00:01:28] but consideration of international impact of policy decisions should conceivably be a part of the conversation.
[00:01:34] The second half of our discussion focuses on Raghu's most recent book, Breaking the Mold,
[00:01:39] in which he reviews the progress and challenges in India.
[00:01:42] Here he documents the diverging paths of India and China and makes recommendations
[00:01:47] for how India can learn from what China has done while recognizing both the constraints
[00:01:51] and opportunities associated with today's global economy.
[00:01:55] He argues that India is uniquely positioned to provide high value added services in a digital and remote work economy.
[00:02:02] I hope you enjoy this episode of the Alpha Exchange, my conversation with Raghuram Rajan.
[00:02:10] My guest today on the Alpha Exchange is Raghuram Rajan.
[00:02:13] He's the Catherine Dusick Miller Distinguished Service Professor of Finance at Chicago Booth.
[00:02:19] He was also the 23rd Governor of the Reserve Bank of India from 2013 to 2016.
[00:02:26] Spent a lot of time at the IMF as well.
[00:02:29] Dr. Rajan, Raghu, thank you so much for being a guest on the podcast today.
[00:02:33] Thanks for having me, Dean. It's a pleasure to be with you.
[00:02:36] Yeah, absolutely. Looking forward to the conversation and what we're going to do here is
[00:02:40] review two recent pieces of work that you somehow amidst an incredibly busy schedule find time to do.
[00:02:48] The first is going to be on monetary policy and specifically, you talk a lot about the side effects
[00:02:54] of monetary policy in your book. So we're going to dive into that.
[00:02:57] And then you're just out with a new book really interesting called Breaking the Mold on India.
[00:03:02] Some of your thoughts on where India has been, where it can get to and your analysis of what India can do
[00:03:10] from a reform standpoint in light of what is a unique time in the global economy,
[00:03:16] what we can learn from the past and what India needs to do differently.
[00:03:19] So I'm eager to get into that one as well.
[00:03:21] First, let's start with monetary policy. Maybe step back.
[00:03:24] We're here with a short rate at five and change percent.
[00:03:29] Feels like it's going to be stuck there for a little bit longer than people thought.
[00:03:33] I think at the beginning of the year, we had seven cuts priced.
[00:03:37] We barely have a little bit more than one price now.
[00:03:40] So this is evolving as the inflation data evolves.
[00:03:44] Your book, Monetary Policy and Its Unintended Consequences,
[00:03:47] I think even the title is so thought provoking.
[00:03:51] So it's going to give us a lot to get into.
[00:03:53] And you kind of go chapter by chapter.
[00:03:55] So I wanted to start with one of the earlier parts of the book and just this broad question
[00:04:01] of central banks and what I would just put in the category of mission creep
[00:04:06] and the tendency towards asymmetry, meaning being probably a rightful lender of last resort
[00:04:13] during episodes of crisis, but politically running into challenges towards normalization
[00:04:20] during non-stress periods.
[00:04:22] Maybe that's the period between the two crises, the 2008 financial crisis and the 2020 pandemic.
[00:04:28] So I'd love to start there and just get some of your thinking on just the broad potential
[00:04:35] for mission creep, where central banking should start and end and what we've learned
[00:04:40] from the past 20 odd years.
[00:04:42] First, thanks for talking about these books.
[00:04:46] I think the book, Monetary Policy and Its Unintended Consequences,
[00:04:50] is really a time series of my own thoughts on the subject,
[00:04:54] trying to convince myself that there is some continuity in this process
[00:04:59] and that it's been a process of development.
[00:05:02] I guess I sort of really moved into this while I was at the International Monetary Fund
[00:05:07] and talked about the risks that were building up in the financial system in 2005
[00:05:13] in a speech at Jackson Hole.
[00:05:15] I was talking about the effects of easy money on risk taking.
[00:05:20] It was there for anyone to see.
[00:05:21] It's not that I was talking about anything completely outside the realm of possibility,
[00:05:27] just it was when I joined the dots, it suggested there was a possibility of a serious crash.
[00:05:33] There was a possibility.
[00:05:34] I wasn't predicting that it would happen, but it happened.
[00:05:37] And then I have been thinking about the reactions to that and what exactly we've done.
[00:05:44] And to some extent, it's back to an old Chicago view,
[00:05:47] most associated with Milton Friedman,
[00:05:50] that central banks cannot do only so much,
[00:05:53] increase money supply at a fixed rate.
[00:05:55] I think we've moved beyond that.
[00:05:57] I think the basic idea still holds.
[00:05:59] Central banks can do only so much.
[00:06:01] And when they try to do more, they risk the unintended consequences,
[00:06:06] which is the dealing with a financial sector,
[00:06:09] which can essentially take off on its own.
[00:06:12] And by being overly accommodative for a long time,
[00:06:16] by offering asymmetric policy, benign in good times,
[00:06:20] but very supportive in bad times, we risk creating a problem.
[00:06:25] That's really where this comes from.
[00:06:28] Happy to talk about the details.
[00:06:30] So as you reference your talk at Jackson Hole in 2005,
[00:06:33] I can't help but remember Alan Greenspan,
[00:06:36] who was testimony in front of the Senate Banking Committee.
[00:06:38] It might have been 06.
[00:06:39] It was either 05 or 06.
[00:06:41] But he said, and I'm going to quote here because I've used this so many times,
[00:06:44] history has not dealt kindly with the aftermath of protracted periods
[00:06:48] of low risk premium.
[00:06:50] And he's effectively channeling Minsky there.
[00:06:54] Essentially, the financial system can become unwieldy
[00:06:57] and these asset prices can become so pro-cyclical.
[00:07:00] And I think what's interesting, and I'd love for you to reflect on it,
[00:07:02] is right now we've got one of these periods here.
[00:07:05] I look a lot at implied volatility around the world,
[00:07:08] across the asset classes.
[00:07:09] And these are not 2006 lows, but they're very, very low.
[00:07:14] And yet the system, it always has its sources of fragility,
[00:07:19] but it's a lot less of a powder keg than it was back then.
[00:07:23] And so you made these forceful statements at Jackson Hole.
[00:07:26] You wrote about it in Fault Lines.
[00:07:28] And I think where I'd love for you to provide some of your thought process
[00:07:32] and insights is on the political will to do something
[00:07:35] in light of the party's going, and it feels good,
[00:07:38] and it's just hard to undo something like that.
[00:07:41] Just take us through that, if you can,
[00:07:43] when times are good trying to maybe step in.
[00:07:47] Well, you mentioned Greenspan.
[00:07:49] And he had another statement at Jackson Hole.
[00:07:52] And I don't have the detailed statement in front of me,
[00:07:55] but it was after the dot-com bust, when a couple of years later,
[00:08:00] he talked about what the Fed had done.
[00:08:03] And he basically said,
[00:08:04] we can't recognize and cut off the bubble when it's happening,
[00:08:08] but we can come in afterwards to pick up the pieces
[00:08:12] and move back to a normalization of the economy.
[00:08:15] That was essentially the statement which emphasized the Greenspan put.
[00:08:20] We're not going to stand against the bubble as it builds up,
[00:08:23] but we're going to pick up the pieces when it breaks down.
[00:08:26] In my sense, is this asymmetry, this is one form of asymmetry.
[00:08:30] I'll come to another one in just a second.
[00:08:32] This asymmetry is fully built into Fed policy today.
[00:08:36] Think about what happened in the March 2023 crisis.
[00:08:40] You had the March 2023 events
[00:08:43] when you had the sudden collapse of four banks.
[00:08:47] What did the Fed do after the first bank SVB collapsed?
[00:08:51] It essentially invoked what is called the systemic exemption
[00:08:56] and bailed out all the uninsured depositors.
[00:08:59] Effectively sent the message to the system.
[00:09:01] There were 22 other banks, I understand,
[00:09:03] which were experiencing runs at that time.
[00:09:05] It was an attempt to calm the system down,
[00:09:07] but saying we'll bail out anybody who matters at this point.
[00:09:12] And so the run stopped. That was good.
[00:09:15] But it came at the cost of basically saying riskless investment.
[00:09:19] You don't have to worry about being in uninsured deposits.
[00:09:23] We will take you out whole.
[00:09:25] I think that's been the nature.
[00:09:27] I think Chairman Powell tried to get away from it.
[00:09:30] The asymmetric support to markets in 2018,
[00:09:33] when the Fed very strongly signaled
[00:09:36] that it wasn't going to be afraid
[00:09:39] to allow market volatility to play out,
[00:09:43] that it would not necessarily focus on the market at all.
[00:09:47] But then in December 2018, the Fed turned on a dime.
[00:09:51] The only thing that happened between FOMC meeting
[00:09:55] and when the Fed actually turned
[00:09:57] through the speeches of its leadership
[00:09:59] was the market was tanking.
[00:10:01] And the Fed turned around and said,
[00:10:03] we're going to become more accommodative.
[00:10:05] And so unfortunately that put has been reinforced again
[00:10:10] and again and again.
[00:10:12] And at this point it's hard to see the Fed
[00:10:15] letting anything which is above 25 billion in size
[00:10:19] go in the banking system
[00:10:21] because the lessons from past episodes
[00:10:24] are so firmly ingrained
[00:10:26] that it'd be a brave regulator who attempts to see
[00:10:29] whether the system can absorb a loss like that.
[00:10:32] There's one part of this book as well
[00:10:33] where you talk about this idea of financial cycles.
[00:10:37] We live in an economy,
[00:10:38] but we also have this just vast massively interconnected
[00:10:43] and gigantic financial system.
[00:10:45] And so this is sort of anti-Greenspan.
[00:10:47] He said, look, let it go when and if it ultimately busts
[00:10:50] just be there to pick up the pieces,
[00:10:52] exigent circumstances type of stuff.
[00:10:54] But you're suggesting I think at least exploring
[00:10:57] some pushback on that.
[00:10:59] I'd love to learn a little bit more about that.
[00:11:01] So I think the question is,
[00:11:03] how do we get to the bottom of this?
[00:11:05] And I think the question is,
[00:11:07] how do we get to the bottom of this?
[00:11:08] And I think the question is,
[00:11:09] how do we get to the bottom of this?
[00:11:11] And so, what I'm trying to say is
[00:11:13] if you're thinking about the system as a whole,
[00:11:15] then the question is,
[00:11:16] is there a way to push back on that.
[00:11:19] I'd love to learn a little bit more
[00:11:20] about your thinking there.
[00:11:21] So this is something which has become a form of doctrine
[00:11:25] amongst some central bankers,
[00:11:27] what they call the separation principle,
[00:11:29] that monetary policy is about the usual activity.
[00:11:34] If you want to talk about financial stability,
[00:11:37] talk about macroprudential supervision,
[00:11:39] which is an entirely different department.
[00:11:41] but it's convenient to say there's somebody else looking after it.
[00:11:45] And I think that's dangerous because what you get is the possibility of monetary policy
[00:11:51] having its foot on the accelerator because activity is not meeting the twin goals of low
[00:11:57] inflation and maximum employment, even while the financial risks are building up.
[00:12:03] And you're basically saying somebody else will take care of it.
[00:12:06] Well, when you have your foot pressed on the accelerator, it's unlikely somebody
[00:12:11] else will take care of it.
[00:12:13] And what we now have is a rash of studies which basically say the two are connected.
[00:12:20] Easy money, I mean this is Minsky as you pointed out earlier, but Minsky has been verified
[00:12:25] again and again now in studies saying easy money leads to bad consequences.
[00:12:32] A sample title is credit bites back.
[00:12:34] Easy credit eventually bites back because it creates the basis for downturns.
[00:12:41] And I think that one is that.
[00:12:43] That is established.
[00:12:44] The second thing that you're seeing some evidence come out on, Neil Ferguson at Stanford
[00:12:50] has done some work along with others on this, is this idea that central bank intervention
[00:12:56] breeds eventual need for more intervention.
[00:12:59] In other words, moral hazard, which we said is for the birds, actually exists.
[00:13:05] When you intervene, people think you will intervene again.
[00:13:08] Just look at what happened during the global financial crisis.
[00:13:12] We intervened in a big way.
[00:13:13] Of course, in March 2020, when the pandemic hit, of course we can say the pandemic is
[00:13:18] a once-in-a-century event, etc.
[00:13:21] But every spread we know went haywire and the Fed intervened in such a massive way
[00:13:27] then.
[00:13:28] But that didn't stop the intervention.
[00:13:29] March 2023, the Fed had to intervene again.
[00:13:33] Have we moved from socialism for the masses to socialism for the well-connected, in this
[00:13:41] case financial firms?
[00:13:42] I mean, a bunch of firms that were way out on a limb on their trades basically
[00:13:49] got bailed out by these interventions.
[00:13:51] And that suggests riskless capitalism, which is always a problem.
[00:13:55] The interventions in the Treasury market are just a source of ongoing fascination
[00:14:00] for me from 2020.
[00:14:02] Just the scope of that really unlimited, I think it was March 23rd, the statement came
[00:14:08] out and it was in amounts as needed.
[00:14:11] Your size is our size.
[00:14:13] There's no size that we'll stop at.
[00:14:15] And you're right, it did bail out lots of private counterparties that had things
[00:14:21] like basis trades on and so forth.
[00:14:23] I also wanted to just talk to you about the QE era that was the non-emergency era.
[00:14:29] I think as we get past this and it's farther enough away, sometimes things in the rear view
[00:14:35] get harder to really appreciate.
[00:14:37] But I was looking back, I just kind of set the stage here, I was looking back at
[00:14:40] some prices back in 2014.
[00:14:43] And of course, the policy rate was still stuck at zero.
[00:14:46] But what was so fascinating to me was when I looked at one year forward rates, they
[00:14:51] were still really close to zero.
[00:14:54] And so that promise from Bernanke of we're at zero and we are absolutely positively
[00:15:00] staying here creates an entirety of trades that effectively profit from that roll down.
[00:15:08] They are collectors of the vol risk premium at very skinny levels, but you're almost
[00:15:12] guaranteed success.
[00:15:14] And then, of course, all of the bond buying during non-emergency times.
[00:15:18] So we'll drill down into some specifics, but I'd love for you to just share what's
[00:15:24] on your mind as you wrote this book and thought through that period as well.
[00:15:29] We actually did some research on QE to see what the consequences were.
[00:15:35] And believe me, Silicon Valley Bank is tied to QE.
[00:15:38] And I'll tell you how.
[00:15:39] So you have this massive expansion of the Fed balance sheet.
[00:15:43] It's issuing reserves to buy back bonds.
[00:15:46] And obviously, this has to be a counterpart.
[00:15:49] Who's it buying back bonds from?
[00:15:52] It can buy back from the banks, in which case for the banks, it's simply an asset
[00:15:55] swap of reserves for bonds.
[00:15:58] But if it buys from the public pension funds, insurance companies, which is what
[00:16:02] it ended up doing, essentially as the Fed expands its balance sheet, the banks
[00:16:07] also expand their balance sheet because the public can't hold reserves.
[00:16:10] What it does is it deposits the payment it gets from the Fed for the bonds
[00:16:14] it sold in the bank.
[00:16:15] The bank has then an outstanding deposit counterparty of that outstanding
[00:16:19] deposit is reserves.
[00:16:21] So bank balance sheets also expand, and they expanded hugely during this time.
[00:16:26] How did they expand?
[00:16:27] It's interesting because what they did was they reduced time deposits and they
[00:16:34] increased demand deposits, especially uninsured demand deposits.
[00:16:38] So uninsured demand deposits really take off from 2009.
[00:16:43] Silicon Valley Bank had 90% of its deposits uninsured demand.
[00:16:47] It was an outlier, but it wasn't a coincidence.
[00:16:51] That was happening across the banking system.
[00:16:55] That's why I said 22 banks had this run.
[00:16:57] Now those same banks see a fire hose of money coming into them.
[00:17:03] And what do they do with it?
[00:17:04] Well, they could invest in really short-term treasuries and earn
[00:17:08] pretty much nothing.
[00:17:09] Or they could take interest rate risk, invest in longer-term instruments.
[00:17:14] For Silicon Valley Bank, its band sheet expanded from $50 billion in 2018
[00:17:20] to $200 billion plus in 2023.
[00:17:24] If you put $100 billion of these deposits in treasuries earning nothing,
[00:17:29] you're quote unquote wasting it.
[00:17:31] If on the other hand, you put them in long-term treasuries,
[00:17:34] they're still safe.
[00:17:35] They earn very little capital charge, but you make that spread.
[00:17:39] So the oldest of old plays, which is taking on interest rate risk,
[00:17:44] became something a lot of banks did.
[00:17:47] As some early studies suggested, the kind of losses
[00:17:50] they have on their long-term instruments, which if you stop the run
[00:17:54] will be absorbed over time, but were the cause for the run
[00:17:58] in the first place in March 2023 when people recognized
[00:18:01] that a bunch of these banks were virtually insolvent,
[00:18:04] which Silicon Valley Bank was.
[00:18:06] Because the market losses on their long-term instruments
[00:18:09] essentially took them underwater.
[00:18:12] So what I'm saying is the unintended consequences of QE.
[00:18:15] I mean, everybody said QE, oh, all it's going to do
[00:18:18] is bring down long-term yields.
[00:18:19] That's going to encourage businesses to invest long term.
[00:18:23] We'll get the recovery from the long term rather than
[00:18:25] the short term.
[00:18:26] Didn't happen.
[00:18:27] We didn't get that strong recovery.
[00:18:29] What it did was did other stuff, which
[00:18:31] is it caused the financial system to become much more liquidity
[00:18:36] because even as it held reserves,
[00:18:40] it had issued uninsured demand deposits against them
[00:18:43] and even went further issuing lots of lines of credit.
[00:18:46] So in a sense, the illiquidity of the financial system
[00:18:50] at much higher levels of Fed balance sheet
[00:18:53] were not a coincidence.
[00:18:54] They were an active response of the commercial banking sector
[00:19:00] to what was happening.
[00:19:01] And this is what we don't recognize.
[00:19:03] I think the Fed was actually surprised when in 2019,
[00:19:07] September, if you remember, everything blew up.
[00:19:09] It was surprised because it said
[00:19:11] our balance sheet is much bigger than it
[00:19:13] was when we started QE.
[00:19:15] How is it that the system is blowing up
[00:19:17] with so much liquidity spilling around the reserves?
[00:19:21] The answer was the private sector reacts
[00:19:23] to what you've done and has actually eaten up
[00:19:26] all the liquidity and actually wants more.
[00:19:28] So from 2009 to 2019, I'm going to estimate,
[00:19:32] I think it's around maybe 1.5-ish percent was core PCE.
[00:19:37] Some would argue that's too far below 2%,
[00:19:39] but the rationale behind the ongoing non-emergency QE
[00:19:44] was to push back against these deflationary forces.
[00:19:48] You didn't want to get too close.
[00:19:49] It gets very difficult to push it back up.
[00:19:52] What's the scorecard on that?
[00:19:54] The interaction between bond buying
[00:19:57] and all the accumulation during non-emergency times
[00:20:00] and the output, the beta of inflation from a reaction?
[00:20:05] It had very moderate effects
[00:20:07] in elevating inflation over that time, if any.
[00:20:11] My colleague, Lubosh Pastor, has a paper on this,
[00:20:15] which he titles 50 Shades of QE,
[00:20:17] basically saying that all the central banks
[00:20:19] seem to think they had much more effect
[00:20:21] on activity and inflation.
[00:20:23] But anybody outside the central banks
[00:20:25] who did similar studies finds somewhat different results.
[00:20:29] It had very limited effect.
[00:20:31] In fact, the one central bank that finds effects
[00:20:33] going the other way is the Deutsche Bundesbank,
[00:20:35] which historically has been against easy money.
[00:20:39] There's another point here,
[00:20:40] which is that is 1.5% so bad?
[00:20:43] I mean, I think the average from 2012 to 2021
[00:20:48] when the Fed changed its mandate was about 1.2%.
[00:20:53] That's not deflationary.
[00:20:55] That's nowhere near deflation,
[00:20:56] but we have this deflation fetish.
[00:21:00] And actually what you see with Japan is,
[00:21:02] yeah, it was stuck in deflationary mode.
[00:21:05] But what is really important
[00:21:07] is you don't have galloping deflation.
[00:21:09] Some positive inflation is useful
[00:21:11] for prices to adjust appropriately.
[00:21:14] But we had such a fear of deflation,
[00:21:17] chicken little's sky falling on its head,
[00:21:20] that we had really easy money for another 10 years
[00:21:23] in trying to pump up stuff.
[00:21:25] And of course, that necessitated the massive expansion
[00:21:29] of the bank in 2020.
[00:21:31] And remember, effectively there was a bailout
[00:21:34] of the system through the fiscal route.
[00:21:35] The paycheck protection program,
[00:21:37] which sent a lot of money into the hands of firms,
[00:21:40] went out through the back door to repay their banks.
[00:21:43] Why is it that bank loan losses
[00:21:45] from the pandemic were so small?
[00:21:47] Because the public paid for those loan losses
[00:21:50] through all these programs.
[00:21:52] So effectively through the monetary,
[00:21:55] we have taken a huge amount of risk
[00:21:58] balance sheet.
[00:21:59] And that's a worry.
[00:22:00] This is not capitalism,
[00:22:01] this is riskless capitalism for some.
[00:22:04] The other asymmetry, let me quickly point out here
[00:22:07] is that I think we have a good sense
[00:22:11] of how to reduce inflation when it goes high.
[00:22:14] We have much less of a sense
[00:22:16] of how to increase inflation when it goes low.
[00:22:20] And I would say that it usually is other factors
[00:22:23] that are responsible for really low inflation.
[00:22:27] Some of them are benign.
[00:22:28] Some of them are productivity growth
[00:22:29] and that's a good thing.
[00:22:31] But some of them are,
[00:22:32] you're not getting strong investment.
[00:22:34] And the way to deal with that
[00:22:36] is do the right structural reforms.
[00:22:39] You need to get more enthusiasm amongst businesses
[00:22:43] to invest for example.
[00:22:45] Doing it through the monetary route
[00:22:46] by pushing rates down to zero
[00:22:49] and then doing all sorts of fancy stuff
[00:22:50] with the central bank balance sheet,
[00:22:53] in my mind, risks energizing,
[00:22:56] extreme risk taking in the private sector.
[00:22:59] Well, let me just run with something you just said,
[00:23:01] which is we know more about reducing inflation
[00:23:04] when it's high than the opposite.
[00:23:06] And so this is the current circumstance.
[00:23:09] And so I'd love to learn a little bit more
[00:23:12] about your thinking on the stance of fiscal policy
[00:23:16] versus monetary policy.
[00:23:17] It's sort of an inversion of maybe what we had in 2012,
[00:23:22] especially after the Budgetary Control Act.
[00:23:25] For the US that was quasi restrictive policy.
[00:23:29] For our deficits we tend to run
[00:23:31] and now it's the opposite,
[00:23:32] restrictive monetary or at least a high short rate
[00:23:34] and pretty loose fiscal policy.
[00:23:37] If you're trying to get inflation down from here,
[00:23:39] what do you think needs to happen?
[00:23:41] Looking back, many would say that fiscal was
[00:23:45] set at lower level than appropriate
[00:23:47] post global financial crisis.
[00:23:49] But of course, there's only so much fiscal
[00:23:52] that can be absorbed in a relatively short time.
[00:23:55] There were a bunch of departments saying
[00:23:56] we don't know how to spend the money
[00:23:58] which is coming our way.
[00:23:59] So it should have been perhaps for a longer period
[00:24:03] and more balanced over time rather than
[00:24:05] the big surge initially
[00:24:06] and then it sort of started tapering off.
[00:24:08] But you can debate that.
[00:24:10] Unfortunately, the lesson that was absorbed from that
[00:24:13] plus the period of really easy money,
[00:24:15] so this is another unintended consequence,
[00:24:18] is that economists started writing pieces like,
[00:24:21] oh, you can afford a lot more debt
[00:24:24] because debt service is really low
[00:24:25] and that was great when interest rates were really low.
[00:24:28] But of course, interest rates do go up
[00:24:31] and what is easy debt service?
[00:24:33] In times low interest rate becomes a horrendous problem
[00:24:36] as interest rates move up.
[00:24:38] And so I think the unintended consequence
[00:24:40] of the easy money is we can do a lot more fisc
[00:24:44] without any backup, any problem
[00:24:47] and the fisc will get absorbed by the economy.
[00:24:49] It'll ramp up, supply will expand to meet demand,
[00:24:52] et cetera, et cetera.
[00:24:54] After all in the pandemic,
[00:24:55] we have really low demand, we need to enhance it.
[00:24:59] The whole problem was that demand was concentrated
[00:25:02] in some areas and supply was impossible
[00:25:04] to increase in others.
[00:25:06] You couldn't increase hotel services,
[00:25:07] nobody was buying at that time.
[00:25:09] So all the extra demand went on pelotons
[00:25:12] rather than gym memberships.
[00:25:14] You couldn't join the gym.
[00:25:15] It became a huge increase in demand for goods,
[00:25:19] creating the goods backup, the goods inflation, et cetera.
[00:25:22] And now with that easing off and coming down,
[00:25:25] we have the services inflation which is going on.
[00:25:29] The Fed, one could argue whether it reacted late or not,
[00:25:33] but it reacted reasonably when it did.
[00:25:35] The problem was the magnitude of the inflation
[00:25:38] that had been unleashed required fast reaction,
[00:25:41] especially after the Fed had been saying it's transitory.
[00:25:45] However, the Fed trying to have it both ways
[00:25:48] is creating a little bit of a problem.
[00:25:50] It wants the slow down, it doesn't want a recession.
[00:25:54] It's been talking up the rate cuts
[00:25:56] as inflation comes down,
[00:25:57] but of course that immediately gives the market
[00:25:59] an incentive to celebrate saying the rate cuts are coming,
[00:26:02] the rate cuts are coming.
[00:26:04] And if you look at financial conditions today,
[00:26:06] they are no tighter, in fact, they're a little loser
[00:26:09] than when the Fed started raising interest rates.
[00:26:12] And so if the Fed largely works through financial conditions,
[00:26:16] it is not restrictive at this point.
[00:26:19] And that's the big worry
[00:26:20] that they hope that just the talk will be enough,
[00:26:23] not wink-wink or trying to bring down activity.
[00:26:27] But you're seeing that labor markets
[00:26:29] are as tight as they were despite having good luck,
[00:26:33] which is a surge of immigration post pandemic,
[00:26:36] which created more supply to the labor market
[00:26:39] and more participation post pandemic.
[00:26:42] We are at record levels for some age categories
[00:26:45] and both those have not been enough
[00:26:48] to bring down services inflation.
[00:26:51] And of course we're seeing job growth still very strong
[00:26:53] for having raised interest rates so much.
[00:26:57] There's so much debate
[00:26:58] and thinking on the monetary policy cycle,
[00:27:02] this tightening cycle set against the setup coming in.
[00:27:05] And that setup was one where that prepayment option
[00:27:09] on your mortgage to get to that lower rate,
[00:27:13] I don't know how many trillions of dollars
[00:27:15] were prepaid in mortgage land,
[00:27:17] but for probably the first time ever,
[00:27:20] you've got many homeowners
[00:27:22] effectively have JP Morgan upside down.
[00:27:25] You've got 5% on your deposits
[00:27:27] and you've borrowed from the bank
[00:27:29] at two and three quarters, 3%.
[00:27:32] I really don't think you've ever seen something like that.
[00:27:34] To some extent, it's gotta be playing some role
[00:27:37] in blunting the impact of monetary policy.
[00:27:41] Of course, both firms and households.
[00:27:44] Households because nobody is selling their home
[00:27:47] and re-borrowing at these high rates.
[00:27:50] So the high long rates have little effect
[00:27:53] because only a small fraction of houses are turning over.
[00:27:57] Of course, new homes are being sold,
[00:27:58] but even there it has limited effect.
[00:28:01] That's part of the reason you don't see prices
[00:28:03] also adjusting in the housing market,
[00:28:06] which is holding up consumption.
[00:28:08] I think for firms also,
[00:28:09] many of them pushed out the borrowing maturities
[00:28:13] during the pandemic.
[00:28:14] The ones who could borrow long-term
[00:28:16] in that period of easy money,
[00:28:17] which is a good thing that they pushed it out,
[00:28:20] but that also means that for many of them,
[00:28:23] it'll take some time
[00:28:24] for these higher interest rates to bite.
[00:28:26] Again, unintended consequences of a period of easy money
[00:28:30] is monetary policy has somewhat less bite
[00:28:33] as you've allowed people to refinance.
[00:28:37] And one subset of unintended consequence
[00:28:39] that you consider in this book
[00:28:40] would be this idea of spillover.
[00:28:43] Take the Fed as an example,
[00:28:44] perhaps it is thinking about how its policy
[00:28:48] and maybe its forward guidance
[00:28:50] spills over into domestic asset prices,
[00:28:53] but not really thinking too broadly
[00:28:55] about the international scene.
[00:28:57] And so you had a bird's eye view.
[00:29:00] You led the RBI for a number of years.
[00:29:03] I believe your time there started right after
[00:29:06] and certainly still maybe amidst
[00:29:08] the original taper tantrum,
[00:29:10] which imposed itself quite a bit on emerging markets,
[00:29:14] specifically India.
[00:29:15] We saw capital flight,
[00:29:16] the currency sold off quite a bit.
[00:29:18] And so in this book,
[00:29:19] you spend a fair amount of time
[00:29:21] really asking people to consider,
[00:29:24] the reader to consider almost a system
[00:29:27] where monetary policy members
[00:29:30] might almost create a scoring system
[00:29:33] around the potential for spillovers
[00:29:36] and evaluating the causes and effects
[00:29:39] and the pluses and minuses of those.
[00:29:40] So maybe first talk to us about
[00:29:43] what you learned from that
[00:29:44] in terms of leading the RBI during that
[00:29:46] tumultuous period,
[00:29:47] and then this kind of idea around the central bank
[00:29:50] considering spillover.
[00:29:52] So that's part of me as a failed internationalist.
[00:29:54] I have this hope that somehow
[00:29:56] we will adopt cooperative policies.
[00:29:59] But of course, it's the hardest sell
[00:30:01] in a time of increasing nationalism.
[00:30:04] And so I look entirely out of touch,
[00:30:07] but I'm hopeful that ideas come back
[00:30:09] after 10, 15, 20 years,
[00:30:12] and then people sort of dwell on them more
[00:30:14] as the environment changes.
[00:30:17] What I'm talking about is capital
[00:30:19] conveys monetary policy across countries.
[00:30:22] We know that.
[00:30:23] But from the recipient country,
[00:30:25] some forms of capital,
[00:30:27] basically tourist capital,
[00:30:28] comes in for the high returns,
[00:30:30] leaves as soon as it sees higher returns elsewhere,
[00:30:33] which is fine.
[00:30:34] I mean, I'm not saying that people
[00:30:35] shouldn't maximize their returns,
[00:30:37] but from the receiving country,
[00:30:39] it becomes a little bit of a problem,
[00:30:41] which is that you can't actually use that capital.
[00:30:44] You have to be prepared for it to leave.
[00:30:46] And often leaving at the worst time for you,
[00:30:49] it leaves when policy rates increase
[00:30:52] in the industrial countries,
[00:30:53] which puts pressure on the recipient country,
[00:30:57] emerging market,
[00:30:58] to raise interest rates at that time,
[00:31:00] even as the exchange rate is depreciating.
[00:31:02] And there's a lot of concern.
[00:31:03] That was the taper tantrum.
[00:31:05] Concern about policy tightening in the US
[00:31:07] caused capital to leave many emerging markets.
[00:31:11] And of course India was affected.
[00:31:13] Now we were not blameless.
[00:31:15] Our macro was out of sync.
[00:31:17] We had a large fiscal deficit,
[00:31:19] a large current account deficit,
[00:31:20] and inflation was high.
[00:31:22] And to some extent,
[00:31:23] that lesson taught a bunch of emerging markets
[00:31:26] to improve their macro.
[00:31:27] India certainly did.
[00:31:29] We implemented an inflation targeting scheme,
[00:31:31] which has worked well
[00:31:33] during the pandemic volatility and beyond.
[00:31:37] And as a result,
[00:31:38] India has been able to have moderate interest rates,
[00:31:40] even as the Fed has tightened,
[00:31:42] and the currency is still reasonable and so on.
[00:31:46] But the point I was trying to make is that
[00:31:48] in the best of worlds,
[00:31:51] we would try and look at those spillovers
[00:31:53] because they affect the poorest
[00:31:55] and the weakest countries the most.
[00:31:57] Capital flows in when they don't need it.
[00:31:59] And if they're foolish enough to take
[00:32:00] that capital as stable and use it,
[00:32:04] they end up in crisis.
[00:32:05] And the problem this time around
[00:32:07] is not with the emerging markets,
[00:32:09] but with developing countries like Ghana,
[00:32:12] which got really cheap capital during the time,
[00:32:15] the 1910s,
[00:32:16] and then with the pandemic and afterwards,
[00:32:19] they have fallen into virtually serious debt problems.
[00:32:23] Some of them actually experiencing a debt crisis,
[00:32:25] countries like Sri Lanka.
[00:32:27] In all of this,
[00:32:27] you can certainly see some responsibility of the country
[00:32:30] doing things which with hindsight,
[00:32:33] we would say were not appropriate.
[00:32:36] But it is in some ways on the one hand,
[00:32:39] you always say,
[00:32:40] here are the politics in the sending country,
[00:32:42] what can we do?
[00:32:44] But expecting the politics in the receiving country
[00:32:46] to always adjust.
[00:32:48] The receiving country is usually an emerging market
[00:32:50] or a developing country,
[00:32:51] which has terrible politics.
[00:32:53] It's not focused every day on the macro economics.
[00:32:56] So you're expecting both the economically
[00:32:58] and politically weakest countries
[00:33:00] to do the necessary adjustment
[00:33:02] to these kinds of capital flows,
[00:33:04] which they end up not doing.
[00:33:05] And then you have debt problems.
[00:33:07] Debt problems eventually convert into migration problems
[00:33:11] because those countries have a terrible economic situation
[00:33:15] and then people leave.
[00:33:17] And where do they go?
[00:33:18] They are going to go to developing countries.
[00:33:20] So everybody is in a sense gonna be subject to this,
[00:33:24] more so as overlaid on financial problems
[00:33:28] will come climatic problems going forward.
[00:33:31] At this point,
[00:33:32] Indian cities are experiencing 50 degrees centigrade
[00:33:34] weather which is unheard of.
[00:33:37] And so I think this is gonna get worse.
[00:33:39] I think the large emerging markets have figured it out.
[00:33:43] It's the developing countries now
[00:33:45] which are facing the brunt
[00:33:47] of the world.
[00:33:48] Well, let's shift to your most recent book,
[00:33:49] Breaking the Mold.
[00:33:50] It's on India and it's a set of policy prescriptions
[00:33:55] that you make.
[00:33:56] It brings in a lot of analysis to the past.
[00:33:59] It brings in a deep understanding
[00:34:00] of the governance structure of India,
[00:34:03] of the people of India.
[00:34:06] Why don't you step back first
[00:34:07] and just tell us, share with us your motivation
[00:34:09] for writing the book
[00:34:10] and who the intended audience is.
[00:34:13] There is an election going on in India now.
[00:34:15] All elections are important
[00:34:17] but this is a hugely important one
[00:34:18] because it could determine the shape of India's economy
[00:34:22] but also its democracy.
[00:34:24] We wrote this book at first pass
[00:34:27] to persuade the Indian electorate
[00:34:28] that there was a different model.
[00:34:31] I think it was Larry Summers,
[00:34:33] you need a model to be the model.
[00:34:34] So what model do we have
[00:34:36] to beat the current Indian model?
[00:34:39] But the second was also to give the world a sense
[00:34:42] of where India is now.
[00:34:43] It's a 1.4 billion people country.
[00:34:46] Some people talk about it as being the new China.
[00:34:50] I think that's overstated and it's also wrong
[00:34:52] because I don't think India can be a new China.
[00:34:56] I'll tell you why in a second.
[00:34:57] That was the audience
[00:34:59] and the idea was to put some alternative possibilities
[00:35:02] on the table before the elections
[00:35:04] which concludes on June 4th.
[00:35:06] We'll hear the results then.
[00:35:08] In short, the idea was India never did
[00:35:13] well at manufacturing.
[00:35:14] It has some splendid manufacturing industries,
[00:35:16] two-wheelers for example,
[00:35:17] with the world's largest manufacturer
[00:35:20] of motorcycles, scooters, et cetera.
[00:35:22] We even export motorcycles to the US.
[00:35:24] The Royal Enfield is one of those classics.
[00:35:27] The people who ride Harley-Davidson's like that.
[00:35:30] But I think India has broadly not kept pace
[00:35:34] with the kind of manufacturing that China does.
[00:35:37] It's been largely services where India has gone.
[00:35:41] The Indian programmer is iconic.
[00:35:43] So some people say India missed the manufacturing bus
[00:35:46] and that's a bad thing.
[00:35:47] It's a bug and India should go back to that manufacturing.
[00:35:51] To some extent, the current government is saying,
[00:35:53] yes, we wanna go back to manufacturing.
[00:35:56] Of course, there were reasons we missed the bus,
[00:35:58] deficiencies in India
[00:35:59] and we're gonna subsidize our way
[00:36:01] to manufacturing growth.
[00:36:03] And what we're saying in this book
[00:36:04] is that doesn't make much sense.
[00:36:07] When China did it,
[00:36:09] its workers were competing with US workers,
[00:36:11] with the European workers.
[00:36:13] You had the labor arbitrage advantage.
[00:36:16] Today when Indian workers do it,
[00:36:17] they're competing with Chinese workers,
[00:36:19] Bangladeshi workers and Vietnamese workers.
[00:36:23] Who are about as cheap as the Indian workers
[00:36:24] but they also have the same kinds of infrastructure
[00:36:28] if not better infrastructure.
[00:36:30] So in that sense,
[00:36:31] there's no competitive advantage India has.
[00:36:34] Moreover, what you see increasingly is protectionism.
[00:36:37] People think there's space for the China plus one strategy.
[00:36:41] As manufacturing leaves China,
[00:36:43] it'll come to other countries.
[00:36:45] India should take that up and maybe there's some
[00:36:48] but the West doesn't have room
[00:36:50] for another China sized manufacturer coming on board.
[00:36:54] Everybody wants to protect
[00:36:55] whatever little they have of manufacturing,
[00:36:58] even enhance it.
[00:37:00] So in that sense,
[00:37:00] what we're saying is this strategy fails on two counts.
[00:37:03] One, it's much more competitive than it was then.
[00:37:06] There are no rents here.
[00:37:08] And second, there's no space
[00:37:10] because the West is shrinking the space
[00:37:15] for manufacturing led exports
[00:37:17] and that's the natural market.
[00:37:18] The West is a natural market.
[00:37:20] So what do you do?
[00:37:21] Well, there's one place India is succeeding
[00:37:24] which is services.
[00:37:25] India accounts for 5% of global trade in services
[00:37:29] in terms of exports,
[00:37:30] only less than 2% in manufacturing.
[00:37:33] Why is that so important?
[00:37:35] Because India has moved upscale in services.
[00:37:38] It was IT services,
[00:37:41] it was call centers.
[00:37:43] Now it's consultants providing services directly
[00:37:46] from India to companies in the West.
[00:37:49] Now it's engineers doing the research
[00:37:51] and development for a Boeing or a Rolls Royce.
[00:37:55] Goldman Sachs has its second biggest office
[00:37:57] outside the US in India.
[00:37:59] And these are guys working on putting together
[00:38:01] trading models, risk management models and so on.
[00:38:06] So JPMorgan has 3000 lawyers in India.
[00:38:08] 3000 lawyers doing Indian law?
[00:38:10] No, they're doing US law.
[00:38:12] They're writing contracts for the rest of its businesses
[00:38:14] across the world.
[00:38:15] Services has become an internationally traded good.
[00:38:19] And India already has a big place here.
[00:38:23] It has 300,000 chip designers.
[00:38:26] We're working for various companies,
[00:38:28] obviously doing chip design.
[00:38:29] So why not expand on that?
[00:38:32] There are a bunch of advantages,
[00:38:34] harder to protect against that right now.
[00:38:37] Second, it's much more sustainable.
[00:38:39] You're not going into emission intensive goods.
[00:38:42] You're going into services
[00:38:44] which are much less energy intensive.
[00:38:47] And third, you're already there.
[00:38:48] You have a presence.
[00:38:50] You just have to focus on how to grow there,
[00:38:52] which means focusing on your most important asset,
[00:38:55] which is your human capital.
[00:38:57] That's really the point of the book.
[00:38:59] Here's the other part.
[00:39:00] What do you need to go on it?
[00:39:03] You spent some time talking about this concept,
[00:39:05] the smile curve of value added.
[00:39:08] And specifically with respect to India,
[00:39:10] as you were alluding to, this focus on services.
[00:39:13] And then you really detail
[00:39:15] that we're in a new and exciting age
[00:39:17] when it comes to technology.
[00:39:19] And the delivery of those services,
[00:39:21] the opportunity set that comes
[00:39:23] in delivering those services
[00:39:25] is just extraordinarily new, different,
[00:39:27] and potentially very powerful.
[00:39:29] Maybe you can elaborate on that a little bit.
[00:39:32] The smile curve, it's a concept
[00:39:33] that has been popularized by Richard Baldwin.
[00:39:36] It's basically the idea that if you look
[00:39:38] at the stages of the supply chain,
[00:39:41] starting from the beginning on the left
[00:39:43] and the end on the right,
[00:39:45] where is the value added?
[00:39:47] And the value added is the y-axis.
[00:39:50] The most value added, think of an iPhone,
[00:39:53] is in the conception stage,
[00:39:55] in the innovation, in the Steve Jobs
[00:39:57] and his designers sitting in a room
[00:39:59] and planning out what the features will be.
[00:40:02] That's usually value added.
[00:40:03] Apple owns that.
[00:40:05] And then comes the manufacturing stage,
[00:40:07] where you put together components.
[00:40:10] You have the low cost assembly being done.
[00:40:13] Foxconn does that in Taiwan.
[00:40:14] Foxconn does that in China and now in India.
[00:40:18] And that's very little value added
[00:40:20] because it's very comparative.
[00:40:23] The product goes back to those nice Apple stores.
[00:40:26] It goes back to the marketing,
[00:40:29] the content in the app stores, the iTunes,
[00:40:33] and all that is also again owned by Apple.
[00:40:36] So Apple owns both sides of the supply chain,
[00:40:38] the beginning and the end,
[00:40:40] and has outsourced the middle.
[00:40:42] But where's the value added?
[00:40:43] It's on both ends.
[00:40:45] And the least in the middle,
[00:40:46] that's the smile curve.
[00:40:48] And you can see this across a bunch of products.
[00:40:51] The value of Apple on a good day is $3 trillion.
[00:40:55] The value of Foxconn on a good day is $50 billion.
[00:41:00] And that's the difference between occupying the high end
[00:41:03] and occupying the low end.
[00:41:05] I understand Apple doesn't say manufactured
[00:41:07] in the United States, it says designed in California.
[00:41:11] That's reflective of where the value is in this process.
[00:41:16] What we're saying is if you can occupy some of that,
[00:41:20] that's great.
[00:41:21] But also if you think about even manufacturing,
[00:41:23] the Tesla contains 40 million lines of code,
[00:41:26] probably more now.
[00:41:27] A lot of services embedded in manufacturing,
[00:41:30] the electric vehicle is like a super cell mobile phone.
[00:41:34] The parts are not that important.
[00:41:36] I mean, yes, you need a great battery for long life.
[00:41:39] The rest of the stuff is pretty straightforward
[00:41:41] and can be put together.
[00:41:42] It's all the additional stuff that becomes important,
[00:41:46] the design, how the software interacts with the driver.
[00:41:49] That's why some of these mobile companies
[00:41:51] are getting into it.
[00:41:53] Huawei making its own car, for example.
[00:41:56] What this is saying is that services embedded
[00:41:59] in manufacturing, services directly,
[00:42:01] and even manufacturing at the high end
[00:42:04] is probably where the value added is.
[00:42:07] And how do you get there?
[00:42:09] You get there by having smart people,
[00:42:12] creative people, innovative people.
[00:42:14] So entrepreneurship is what you try and expand,
[00:42:18] which takes advantage of the human capital you have.
[00:42:22] And what we're talking about in this book
[00:42:23] is all the fun stuff that's happening in India,
[00:42:26] 3D printed rockets,
[00:42:28] saris made by old craftsmen,
[00:42:30] but sold across the world through websites,
[00:42:33] which assure you of quality.
[00:42:34] Schools, which are teaching at a very high level
[00:42:37] through scripted learning,
[00:42:39] 30,000 lessons on every subject.
[00:42:42] Where the teacher has little freedom,
[00:42:44] it's bad for the teacher,
[00:42:45] but good for the quality
[00:42:46] because even average teachers can teach good lessons.
[00:42:50] Those are the kinds of things we need a lot more of.
[00:42:52] That's creativity, that's innovation,
[00:42:57] that's the way we're going to do it.
[00:42:59] And so, I think that also needs human capital
[00:43:01] far more than India has.
[00:43:03] It has 1.4 billion people,
[00:43:05] needs to train them, skill them much better.
[00:43:08] Yeah, you say this earlier in the book.
[00:43:10] You say Indian governments have done little
[00:43:12] to prepare India's most precious asset,
[00:43:15] its people's capabilities.
[00:43:17] You've touched on it,
[00:43:18] but maybe dig a little bit deeper
[00:43:20] on this idea of not just job creation,
[00:43:24] leaves you optimistic,
[00:43:25] but what do the two do?
[00:43:26] Is where do you see a need to really rethink
[00:43:29] how to make these investments
[00:43:32] effectively have the highest ROE
[00:43:34] for the country as possible?
[00:43:36] So if you look broadly,
[00:43:37] people in the US typically encounter an Indian
[00:43:41] who's been through the best schools.
[00:43:43] It's a selected sample.
[00:43:45] Engineers they meet are from the IITs,
[00:43:47] which are a very high quality school, very selective.
[00:43:50] Doctors are from the Indian medical institutions,
[00:43:53] which are again very selective.
[00:43:55] And so when you see the crème de la crème,
[00:43:57] you sort of think the quality must be high,
[00:44:00] but the average quality below leaves a lot to be desired.
[00:44:04] We graduate depending on the number,
[00:44:06] something like 1.5 million engineers a year,
[00:44:09] but a lot of them are not of the quality
[00:44:12] of the people coming out from the IITs.
[00:44:16] And so the one big question is,
[00:44:18] how do you make more of these people employable?
[00:44:20] A survey, which has been running
[00:44:22] for a bunch of years,
[00:44:24] basically says 50% of Indian graduates are unemployables
[00:44:27] because they haven't learned anything useful
[00:44:29] in their graduate degree.
[00:44:31] And this includes some people
[00:44:33] who get an engineering degree
[00:44:34] simply because the engineering degree
[00:44:36] is not taught at high quality.
[00:44:38] And so we have to absolutely improve
[00:44:41] the quality of education.
[00:44:43] We've expanded quantity significantly,
[00:44:46] both at primary secondary tertiary,
[00:44:48] but also higher education.
[00:44:51] But quality is really important.
[00:44:52] It's an issue the US struggles with.
[00:44:54] It's an issue that India struggles with a little more
[00:44:58] and has to do a lot more in terms of improving quality.
[00:45:01] Where are the answers?
[00:45:03] Some of the answers is putting more money
[00:45:05] into education, health care.
[00:45:07] We have malnutrition,
[00:45:09] which is at really horrifying levels
[00:45:11] and has to be fixed.
[00:45:13] But it also involves a change in governance.
[00:45:16] Much of education is centralized at the state level
[00:45:20] and states are really big in India.
[00:45:22] The state of Uttar Pradesh has 240 million people,
[00:45:26] which is something like the fifth largest country
[00:45:28] in the world by population, if you look at it that way.
[00:45:31] You can't govern education from the state capital.
[00:45:34] It has to be decentralized
[00:45:36] so that parents know they can complain about a teacher
[00:45:39] to the local authorities
[00:45:41] or a teacher who never shows up at school
[00:45:43] instead of having to write a letter
[00:45:45] to the state capital and seeing it ignored.
[00:45:47] So decentralization, I think,
[00:45:49] will be very important in the years to come
[00:45:52] so that public services.
[00:45:53] Today, the state politician has no incentive
[00:45:56] to talk about educational health care.
[00:45:58] Takes too long to fix it
[00:46:00] and they will not get credit for it.
[00:46:02] But the local politician
[00:46:03] has a much greater incentive to do that.
[00:46:06] And you can see that in some states
[00:46:08] that have become much more decentralized,
[00:46:11] they are actually paying much more attention
[00:46:12] to improving the quality of the schools,
[00:46:15] the quality of the healthcare clinics,
[00:46:16] Delhi is an example.
[00:46:18] So I think that we have potential solutions,
[00:46:21] best practices that we can adopt
[00:46:24] to improve quality from the levels they are.
[00:46:27] I mean, if you hear some of the numbers,
[00:46:29] they're actually frightening
[00:46:31] in terms of how much kids are absorbing in school
[00:46:35] and how much learning loss
[00:46:36] that has happened during the pandemic.
[00:46:39] And so far more than trying to invest
[00:46:42] in chip manufacturing,
[00:46:43] which I think is a bad form
[00:46:45] of industrial policy for India,
[00:46:47] I think focusing on spending those enormous resources
[00:46:51] on improving the quality of healthcare and education
[00:46:54] will pay India much higher dividends.
[00:46:56] The ROE as you said is much higher.
[00:46:59] One particular area I think of optimism
[00:47:02] for you in this book is India's democracy.
[00:47:06] You say free speech, independent institutions,
[00:47:08] a civil society and checks and balances
[00:47:10] on the government are assets for India.
[00:47:13] Tell us a little bit more about
[00:47:14] what you see there and then how India can leverage something
[00:47:19] that's not a given for a large country.
[00:47:22] Unfortunately, India has been slipping
[00:47:24] on all democracy indices over the last few years,
[00:47:27] which is very worrisome.
[00:47:29] Democracy is India's strength.
[00:47:30] And this is also a little bit
[00:47:32] playing to the manufacturing versus services.
[00:47:35] The manufacturing part folks say,
[00:47:37] oh, all the countries that succeeded
[00:47:39] did it under more autocratic governments.
[00:47:41] We should go back to that
[00:47:42] because China, Vietnam,
[00:47:45] those are the governments to emulate.
[00:47:47] And what we're saying is no, no,
[00:47:48] if you go the services path,
[00:47:50] then democracy actually has to be stronger.
[00:47:52] Here are four reasons why.
[00:47:54] One is simply democracy offers criticism.
[00:47:58] And so the government knows when people are unhappy
[00:48:01] and knows to adapt accordingly.
[00:48:03] When you suppress criticism, you actually don't know.
[00:48:07] For example, this government doesn't recognize
[00:48:09] there's an unemployment problem.
[00:48:11] Even its white paper on the economy before the elections
[00:48:14] doesn't mention the word unemployment.
[00:48:16] While again and again,
[00:48:17] you hear people saying that's our biggest concern.
[00:48:20] So that's one.
[00:48:21] Governments adapt to criticism, democracy offers that.
[00:48:25] Second, what we're talking about is a bottom up
[00:48:27] improvement in services provided by the government.
[00:48:30] For that, you need people to be able to protest
[00:48:32] when they don't get it.
[00:48:34] In an authoritarian country,
[00:48:35] they don't protest for fear of being put away
[00:48:38] by the local authorities.
[00:48:39] That's the second reason.
[00:48:41] Third, as you know, again and again,
[00:48:43] studies show creativity emerges when you have democracy.
[00:48:46] If we're talking about the creative path,
[00:48:48] that guy who rebels against the scientific establishment
[00:48:52] could equally well rebel
[00:48:54] against the political establishment.
[00:48:56] You can't stop one and allow the other.
[00:48:58] Both require a certain amount of freedom.
[00:49:01] And that's why democracy will foster both.
[00:49:04] It's important.
[00:49:05] And maybe it convinces the guy
[00:49:07] who's rebelling politically to form his own party
[00:49:10] as opposed to overthrow the system.
[00:49:12] And the fourth reason I think is important,
[00:49:14] if you're selling services to the world,
[00:49:16] it's very important the world trusts you.
[00:49:19] And that trust is built by having a democratic government
[00:49:24] on the other side with checks and balances
[00:49:25] on the government.
[00:49:27] Why is TikTok unpopular in the US?
[00:49:28] You fear the Chinese government
[00:49:30] could actually hoover up the data
[00:49:32] that TikTok gathers on US citizens.
[00:49:35] If India enacted a privacy code which says
[00:49:38] the government will not be able to do that
[00:49:40] for Indian companies.
[00:49:42] And if ever it thinks there's a criminal case
[00:49:44] which requires data,
[00:49:45] it has to go through a judicial process,
[00:49:47] which is a check and balance
[00:49:49] that it's not just kind of fishing expedition.
[00:49:52] I think that'll convince a lot of people
[00:49:53] to share their medical data,
[00:49:55] to share their consulting firm data with India.
[00:49:59] So for all these reasons,
[00:50:00] I think democracy makes sense
[00:50:02] for the path India wants to take.
[00:50:04] Of course, democracy has its intrinsic merit.
[00:50:07] People value it, but even that aside.
[00:50:10] Yeah, your last point on the trust aspect
[00:50:13] is a really interesting one and very powerful.
[00:50:15] Well, this is not part of the book,
[00:50:17] but I was hoping we could just end
[00:50:19] with your assessment of monetary policy there.
[00:50:24] I was reading, you tell me if this is correct,
[00:50:25] but there's a tolerance ban from two to 6%,
[00:50:29] not like the two decimal points 2.00 for the Fed.
[00:50:32] So maybe a little bit more realistic.
[00:50:34] And at least what I saw was
[00:50:36] maybe year over year is around 5.8, I think.
[00:50:39] What's your view on the current state of central banking
[00:50:43] and inflation in India?
[00:50:45] There is a ban in India
[00:50:47] and the general marching orders for the Reserve Bank
[00:50:51] is try and get towards the center wherever you are.
[00:50:54] So four is approximately where you should be,
[00:50:56] but you can move up and down.
[00:50:58] So there is tolerance
[00:51:00] and I think it's worked reasonably well.
[00:51:01] You don't fret too much on either side
[00:51:04] unless you risk getting out of that band.
[00:51:07] We've actually got into the band during my time
[00:51:10] and have stayed largely in that band.
[00:51:13] The reason we kept it wide
[00:51:14] is we weren't that sure we could fine tune,
[00:51:18] especially in the face of shocks.
[00:51:20] And so we wanted some ability.
[00:51:22] Now over time when they reassess it,
[00:51:24] maybe they make it tight over time
[00:51:26] or maybe they let it be where it is
[00:51:28] because people have gotten used to it.
[00:51:29] It's worked well and I'm happy that that's where we are.
[00:51:33] Fantastic.
[00:51:33] Well, I wonder if the Fed
[00:51:34] didn't have such an exact target.
[00:51:37] It might take some of our well-meaning officials
[00:51:40] perhaps off the interview circuit and constantly speaking.
[00:51:45] Sometimes the Fed looks like
[00:51:46] it's trying to do a little too much
[00:51:48] and so maybe a band is a little bit more realistic.
[00:51:51] I feel privileged to have had this conversation with you.
[00:51:53] I think this was tremendously insightful.
[00:51:56] I'm really glad to have had an opportunity
[00:51:58] to talk to you not just about monetary policy,
[00:52:00] which is where we've often connected
[00:52:02] and put on this new and really interesting
[00:52:04] and important work, Breaking the Mold on India.
[00:52:07] So thank you very much for your time.
[00:52:09] Thanks for having me and hope to talk to you soon.
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