Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Monetary Policy and the Indian Economy with Raghuram Rajan (former Governor of Reserve Bank of India)

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Monetary Policy and the Indian Economy with Raghuram Rajan (former Governor of Reserve Bank of India) · The Capitalism and Freedom in the Twenty-First Century Podcast

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  [MUSIC]
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  >> Jon Hartley: This is the Capitalism and Freedom, the 21st Century podcast,
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  an official podcast of the Hoover Institution Economic Policy Working Group,
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  where we talk about economics, markets, and public policy.
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  I'm Jon Hartley, your host.
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  Today my guest is Raghuram Rajan, who's a professor of finance at the University
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  of Chicago Booth School of Business.
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  He previously served as the 23rd governor of the Reserve bank of India,
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  is the chief economic advisor to the government of India under Manmohan Singh,
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  and chief economist of the IMF.
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  Raghu is also a very acclaimed academic.
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  In 2003, he received the inaugural Fisher Black Prize,
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  which is given every two years by the American Finance Association
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  to the financial economist younger than 40, who has made the most significant
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  contributions to the theory and practice of finance.
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  And also in the 2000s, he famously predicted the global financial crisis.
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  Welcome, Raghu.
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  >> Raghuram Rajan: Pleased to be here.
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  >> Jon Hartley: I wanna first talk about your background.
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  You grew up in India.
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  How did you first get interested in economics?
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  And what was your path to doing a PhD at MIT?
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  >> Raghuram Rajan: Well, I think when you're in a poor country.
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  My father was a diplomat, so we had spent some time in Europe.
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  And when I came back to India,
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  the first thing that hit me was how little there was in the shops.
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  Milk was rationed, bread was rationed.
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  You had to essentially make friends with the shop owner to get half a loaf of
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  bread.
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  And you wondered why this was the case.
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  Why was it that we were poor?
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  I mean, the people I met at school weren't any less smart
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  than the people I had been at school with in Belgium.
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  And so the desire to know more about that,
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  to do something about that,
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  was ingrained from that early age.
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  Of course, in the middle, I wanted to be a fighter pilot and all.
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  The other fun stuff that young boys want to do.
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  But as I graduated from school,
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  I think what many Indians do is they sit for
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  a very competitive exam to enter the IITs.
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  And I'd studied a lot and sunk cost fallacy.
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  Once I'd studied, I thought I should take a degree in engineering.
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  That seemed like a sure way to get a job.
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  And job security is quite important.
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  So I went to one of the IITs somewhere in the middle of my third year.
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  I said, what the hell am I doing here learning fields and waves.
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  I just can't connect to that.
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  And that sort of caused a slow movement away
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  from engineering to first management degree, and
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  then eventually the PhD, which was at Sloan.
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  So it was a management PhD, but in finance, and
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  I took a lot of classes in the economics department.
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  So that's how I gravitated towards economics.
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  >> Jon Hartley: Well, that's fascinating.
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  And I want to drill down into some of your research.
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  You've done a lot of really seminal work on banking, a lot of it with Doug diamond,
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  who recently won the Nobel Prize.
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  What have been some of the biggest findings from your research in banking and
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  what do you think has held up best over the years?
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  >> Raghuram Rajan: Well, I think that perhaps the most important finding
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  is the one that we're still battling people on,
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  which is the notion that there's a purpose behind the structure
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  whereby banks are financed with short term debt and lend long.
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  This mismatch is not just because you want to give people access to liquidity,
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  which is what Doug focused on in his early work, but
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  also because it may well be a very effective form of governance.
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  Not so much that the short term deposit holders
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  are sort of monitoring your every move and
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  they know more than the market or they know more than the board.
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  By the way, bank boards are typically relatively clueless about what's going
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  on in the bank apart from what the CEOs tell them.
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  But it's really that it's a very effective punishment mechanism if the banks trace.
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  If you go off track and you can't actually make payments,
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  you get closed down immediately.
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  That's the bank run.
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  And so it's an effective punishment mechanism which
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  doesn't really require anybody to monitor,
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  apart from just making sure they test the bank periodically.
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  Somebody's testing it always, saying I want my money, and
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  if as soon as the bank can't deliver it, it gets closed down.
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  This to my mind explains the structure of banks for 5,000 years.
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  It's not that in Babylon banks had interest tax deduction and
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  therefore they had the structure, or in Italy,
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  it's that it's a very effective punishment device.
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  Of course, augmented in Barcelona, if you defaulted on your debt,
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  you were put on a diet of bread and water until you delivered to your creditors,
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  and if you didn't past a certain time,
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  you were executed, you had your head lopped off.
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  I think that added to the kind of punishment mechanism.
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  But I think if you look at the free banking era,
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  you look at every era of banking.
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  Yes, the short term claim offers liquidity services, but
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  it's also a punishment device.
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  And both are critically important to how a bank works.
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  >> Jon Hartley: I know there's also the debtors prison era as well.
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  It's fascinating these different time periods and yet in banking,
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  I mean, the purpose of banking serves maturity transformation.
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  And certainly, banking I think is certainly undergo a massive rethinking
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  since the global financial crisis.
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  I wanna talk a little bit about the global financial crisis.
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  Obviously there's been a lot of discussion about regulation.
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  Since then, there's been Dodd-Frank,
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  Basel III capital requirements that have been imposed throughout the world.
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  I mean, you famously predicted the buildup in mortgage credit ahead of
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  the global financial crisis with 2005, now famous Jackson Hole speech,
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  which I think then in 2005 was much maligned but
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  later vindicated after the global financial crisis of 2008, 2009.
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  And what led you to that insight in 2005?
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  And I know a lot of this is encapsulated in your book Fault Lines,
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  but what led you to think about that maybe that there's excessive mortgage
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  credit in the system and that that could potentially be a systemic concern?
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  >> Raghuram Rajan: Well, to some extent it was academic perversity.
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  I was the chief economist of the IMF at that point and
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  I was asked to speak on this occasion.
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  And it was Alan Greenspan's last hurrah as chairman of the Fed, and
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  he had given some memorable speeches at Jackson Hole.
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  Everybody was waiting to hear his last speech.
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  But also there were a parade of people sort of saying he was
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  such a great central banker.
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  And there was some debate as to whether he was the best US central
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  banker in history or just a second best.
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  And you know, in this I, I sort of thought initially of writing a piece and
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  how, how all the developments that had happened during his time,
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  including liberalization, et cetera.
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  But then as I started looking at the data, I said, well, wait a minute, there's
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  all this risk in the system and there's a real question of where it's gone.
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  Because suddenly the system doesn't seem to be that bothered about risk anymore.
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  Where really has it gone if the banks aren't taking risk?
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  Who is taking risk?
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  And how are the banks making money if they're not taking any risk?
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  The conclusion I came to after thinking about it a bit was really that the banks
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  were taking tail risk and getting paid for it without the risk showing up.
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  What that meant was just like insurance companies, you get a premium but you know,
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  they're taking risk and they know they have to pay out, right at some point.
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  Well, the banks were taking the risk, getting the premier looking really
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  profitable, but when the day came to pay out, they might look really bad.
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  That was the underlying sort of idea behind that talk.
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  And then I documented the various ways they were taking this tail risk.
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  And then the question was, which was the real important question at that time?
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  Why are the smartest guys on the planet doing this?
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  And the pushback I got was precisely that, these are the smartest guys on the planet.
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  They figured it out.
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  They probably hedging it appropriately and you know,
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  you're surmising that the risk is with them.
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  They've laid it off, it turned out they hadn't.
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  It turned out, I mean, just as I conjectured that they were all
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  taking these tail risks on their balance sheet and when push came to shove,
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  they could not get rid of the stuff and it took the biggest amongst them down.
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  One clear example I gave in that talk was credit default swaps,
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  which are as close to insurance when you write them,
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  you're insuring bonds and loans against default and
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  saying pay me a premium and I will come in to pay it off if the bonds default.
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  AIG had written a ton of these and
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  AIG was thought of as a really spectacularly good credit risk.
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  And then suddenly, it blew up during the global financial
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  crisis because it had taken these tail risks.
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  So, I guess I was lucky because what I
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  had conjectured actually worked out.
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  I was obviously not happy that it happened, but
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  I was relieved that I didn't have my, you know, hang,
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  I didn't have to hang my head in, in shame for the rest of my.
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  I remember Leaving home at that point to go to the conference and telling my wife,
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  this will either make me or break me.
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  Because I was the chief economist of the imf.
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  So people did pay a little bit of attention.
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  But of course, since what I said wasn't very popular,
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  there's very little reporting of it in the press.
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  After I gave that talk, despite, as I said,
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  the position that I held, it was not popular.
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  And then things happen.
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  >> Jon Hartley: I think Larry Summers had, I think, famously made some comments,
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  I think maybe calling you a Luddite or something like that.
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  It's amazing to think how much has transpired since then and
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  in the aftermath of the global financial crisis.
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  I want to talk a little bit more about your amazing career in policy.
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  You had this first big policy job as a chief economist of the IMF.
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  I'm curious, what did that teach you and
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  how did it come about exactly in the early 2000s?
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  >> Raghuram Rajan: Well, I was a financial economist, as you've noted,
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  and it turns out that the IMF was looking for
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  a financial economist at that time.
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  After the East Asian crisis, they recognized that there are a lot
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  of macro economists and people who knew the real sector side, but
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  very few who were familiar with the financial sector and
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  I had been friendly with Anne Krieger,
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  who was the first deputy managing director at that point.
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  She called me up and said, would you like to try out for chief economist?
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  Our current chief economist, Ken Rogoff, is leaving.
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  And I was really surprised because I didn't think I belonged in the imf.
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  I was not a macroeconomist, and I thought, if anything, I would be a better fit for
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  the World bank as a financial development economist rather than a macroeconomist.
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  So I told Ann, let me confess, I don't know any macroeconomics.
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  And she said, well, that makes two of us.
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  And that sort of sealed it, if she could, she's obviously a great trade
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  economist and knows everything there is to know about macroeconomics.
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  But it sort of gave me the sense that she would be supportive, as I learned.
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  And, you know, I had done the regulation courses,
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  I mean, the required courses at mit.
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  I had done a macro class with Olivier Blanchard,
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  one of the great teachers there but this, I said, fine.
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  And it turns out that macro, at least as is practiced in policy circles,
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  is not that difficult to pick up.
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  As a colleague of mine said, the only thing you have to know
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  is which variable to pick as the exogenous variable.
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  Everything is endogenous.
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  So different people have forever debates on what's Exogenous.
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  As you know, we have a debate right now as to whether the US Trade deficit is
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  driven by everybody in the world wanting US Financial assets and
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  therefore forcing the US to run a trade deficit or.
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  Or the US Running a large fiscal deficit and
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  therefore overspending relative to the savings.
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  This debate will go on forever because it's everything's
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  endogenous in macroeconomics.
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  >> Jon Hartley: Yeah, everything is endogenous, that's absolutely right.
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  Yeah.
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  It's fascinating that you say that, I think, yeah,
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  macro is definitely a very theoretical discipline within the academy.
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  But I think it's interesting, once you sort of get into the policy world, it ends
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  up being a lot of empirical macro things that I think are perhaps of most interest.
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  And I'd say that's probably true with respect to macro on Wall Street and
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  finance as well, to some degree.
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  I want to talk just a little bit about your time as a policymaker in India.
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  You served as chief economic adviser to the government of India under Mohan Singh,
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  Singh just recently passed.
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  What do you think the Singh economic policy legacy is?
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  >> Raghuram Rajan: I think it's actually a very important
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  one in the sense that he came in when India was in crisis.
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  Had gone to the IMF.
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  And he decided, I mean, he was the old
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  traditional sort of Indian economist.
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  He'd been to Cambridge but had studied with people like John Robinson.
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  I think he was more of the old interventionist school,
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  but he knew what the alternatives were.
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  And he had spent a lot of time in India in various policy,
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  wearing various policy hats and he knew the system wasn't working.
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  So in a sense he was an insider willing to bring outside thoughts and
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  he really went about liberalization.
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  He had a very supportive Prime Minister, Narasimha Rao, but
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  as Finance Minister he really created a revolution.
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  And you know, he was one of the,
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  it's not clear that there were that many establishment economists in
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  India at that point willing to take the risk and be out there.
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  And he did.
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  We forget now, we sort of think this was easy, but
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  it required a, a tremendous, tremendous courage and
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  a willingness to, you know, to embrace the unknown.
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  He did it, it worked.
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  And now of course, everybody sort of thinks it was a piece of cake.
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  It wasn't.
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  And you know, he was a very mild mannered man, very mild mannered.
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  You'd walk into a room and everybody would be speaking, but
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  the Prime Minister, when he was Prime Minister would not.
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  He listened, and then you realize he's actually
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  been paying attention and he knows what's what.
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  >> Jon Hartley: It's amazing.
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  And for our listeners that aren't really familiar with Manmohan Singh and his
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  legacy, I mean, he serves Finance Minister in the early 90s in the Rao government.
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  And was really the central advocate for what's now referred to as the Rao reforms.
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  And this is a period of economic liberalization that
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  was followed by a massive surge in economic growth in India.
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  And it's a fascinating story in of itself.
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  And we'll talk a little bit more about growth in India in a minute.
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  But you also want to just talk about inflation for just a moment.
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  I mean, in monetary policy,
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  you were the 23rd governor of the Reserve bank of India.
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  I mean, what is the history of inflation and central banking in India?
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  And how did your tenure change that?
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  >> Raghuram Rajan: So I, again, this is Dr.
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  Manmohan Singh's foresight.
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  He was very good at bringing people in from the outside.
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  And he had brought a number of economists from the World Bank,
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  from various Washington organizations back to India to help with reforms.
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  One of which was his strong ally, Dr. Montec Singh Alawalia.
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  But what Dr. Manmohan Singh asked me to do was to
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  write a plan for financial sector reforms.
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  This was after I had served as IMF chief economist,
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  and it was sort of a fascinating sort of task.
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  What all would we change if we had a free hand?
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  And I wrote that report, gave it to him and it sat on a shelf.
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  But he then invited me to be chief economic advisor.
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  That was in a sense a trial to see that I wasn't nuts in some way.
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  And then I was brought in as governor of the Reserve Bank.
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  India was going through the taper tantrum at that time, so a lot of turmoil.
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  The currency had plummeted 25% and because we were subsidizing
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  the price of oil and oil prices were denominated in dollars,
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  that meant the fiscal deficit blew out very quickly.
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  So everything bad was happening.
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  Inflation was double digits, the currency was going through the floor and
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  the fiscal deficit was not good and didn't look good.
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  And I came in and my thought was we need to chalk out
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  an agenda which builds some confidence in markets.
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  So on the first day after I took over, I gave a speech to TV which
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  basically said here are the steps we're going to take.
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  Many of them from that report I had done,
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  which included liberalizing bank branching, etc., etc.
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  But also importantly saying we're gonna move towards inflation targeting.
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  I've asked the deputy governor to chalk out the steps we need to do to move
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  towards that.
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  A whole bunch of steps in terms of reforms were announced on that first day.
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  I think that helped build some confidence that we were back on a reform path.
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  And over time the exchange rate came back to something like normalcy.
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  But importantly, and this is what my Latin American Central bank
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  governor friends had told me, forget about the exchange rate,
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  worry about inflation and say you're worried about inflation and
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  that's going to be key to stabilizing everything.
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  And that's what we said.
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  We said we're on an inflation glide path.
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  We are going down to this level in the space of two years.
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  Here are the intermediate targets.
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  Once we get there, we'll move into full fledged inflation targeting.
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  I don't know how it worked, but it worked.
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  By the time I left, we were in the middle of the band,
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  which was 2 to 6%, which is around 4.
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  We'd started at double digits.
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  And we had signed the pact with the government for inflation targeting..
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  And the committee was met just after I left for
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  the first time, so that was some success.
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  And it stayed largely within the band over the last few years,
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  including in difficult times like the post Covid inflation around the world.
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  And right now it's again trending towards the midpoint of 4.
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  So I think it's been very.
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  People have done studies on it, it's been very successful in
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  bringing inflation down to approximately where it should be.
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  What was important is that we established credibility by not being overly ambitious.
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  So we had this glide path to get into the band, and
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  I didn't want to announce inflation targeting until we were in the ban and
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  were confident we could remain there.
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  And that was what was important to establish credibility.
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  If we had announced inflation targeting and found we had no way of being
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  in the band, then we'd have diminished credibility totally.
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  So it was a process, but I think it'll serve India well.
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  >> Jon Hartley: It's fascinating,
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  bringing inflation targeting into India is a huge accomplishment.
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  And interesting that at some level,
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  how you needed to have a sort of a glide path and that it needed to be
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  something of a gentle evolution rather than a swift revolution.
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  And that is interesting to think about, I guess these sorts of, you know,
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  political economy sort of constraints even when we sort of may have the right idea of
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  what the optimal policy thing to do might be from an economic policy standpoint.
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  I want to talk just a little bit about growth.
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  India is still a poor country, GDP per capita in India today is around
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  $2500 U.S, this is about 5x of what it was in 2000,
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  about eight times what it was in 1991 when the RAO reforms began.
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  What do you think about say the Modi BJP government's attempts to further say,
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  a pro business agenda that perhaps began with
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  the Congress rousing reforms in the early 1990s.
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  What do you think right now needs to be top of mind as it relates to
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  pro growth India economic policy?
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  >> Raghuram Rajan: I think what we need to do is try and figure out what makes
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  sense in an environment where automation is making
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  it very difficult to create a lot of manufacturing jobs,
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  where there is potential impending automation also in
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  services through AI and so on, which is coming down the line.
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  Where most of the big markets are turning protectionist
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  in some way, especially for manufactured goods.
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  Everybody has some sort of manufacturing fetishism,
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  sort of embedded we need to produce stuff because all the other
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  things that we do are sort of ephemeral, not real production.
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  You know, it's the old, what was it, the scholastic view that's come back.
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  >> Jon Hartley: Or something, the mercantilist view or, I don't know.
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  >> Raghuram Rajan: Well, mercantilist on the protectionist side, but
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  on the notion that the only real sort of activities or
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  venerable activities are making things or
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  growing things, agriculture and manufacturing and
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  everything else is a scam, especially finance.
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  Trading also is a semi scam, but finance is the biggest scam of all.
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  Those used to be notions way back but I think that in
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  an environment where it's getting more protectionist and
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  of course in an environment where China is still
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  finds it very hard to get away from manufacturing and
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  has a huge presence there in that environment,
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  where is the space for India to grow?
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  And what I have been arguing is trying the old export led
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  manufacturing growth path is going to be much more difficult and
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  it's not going to create the kinds of jobs that India needs and
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  we need a different growth path.
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  And what I've been advocating in my recent book Breaking the Mold is
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  a focus on service, high Skilled services for the export sector,
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  generating the kinds of foreign exchange revenues you need,
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  but also moderate skilled services focused at the domestic market,
• 27:46
  which India has a big, big one.
• 27:49
  In order to create more jobs, obviously you take what manufacturing
• 27:54
  you can get and you do whatever value added agriculture you can get.
• 28:00
  Agriculture still accounts for a significant portion of Indian jobs,
• 28:05
  but for the modern sector it may have to be more of an emphasis on services,
• 28:11
  both high skilled and moderately skilled, rather than on manufacturing.
• 28:18
  And it's not just a problem for India.
• 28:21
  You see, Indonesia also struggling to create middle class jobs.
• 28:24
  You see, China now struggling to create jobs for youth.
• 28:30
  That manufacturing led growth path is showing its age
• 28:35
  in a world where so many other things have changed.
• 28:40
  And I think we need a growth path for this new world.
• 28:43
  And that's what I've been trying to push.
• 28:46
  The government is entirely focused on building a manufacturing sector
• 28:51
  in India and they also suffer a little from manufacturing fetishism.
• 28:56
  If we're not manufacturing anything, what are we really doing?
• 29:02
  And so they're plying the sector with subsidies and so on.
• 29:05
  But I worry that this is not effective job creation.
• 29:11
  And if you look at the numbers over the last 10 years, in fact,
• 29:15
  look at the last five years, writing off the first five years as a learning phase.
• 29:21
  In the last five years,
• 29:22
  manufacturing has actually created fewer jobs than its share of the economy.
• 29:28
  Services also hasn't done that well,
• 29:31
  because what really has picked up is agriculture,
• 29:35
  which is extremely worrisome in a country which is developing.
• 29:40
  The Arthur Lewis kind of model would say,
• 29:44
  you first drain the agricultural sector of workers.
• 29:50
  And in many modern economies it's 5%.
• 29:54
  In India, it's still a significant number.
• 29:58
  53% of jobs in the last five years were in agriculture.
• 30:03
  And that's not.
• 30:04
  >> Jon Hartley: There's been that big of a pickup in agriculture.
• 30:06
  >> Raghuram Rajan: Not so much a pickup in agriculture as a lack of jobs
• 30:10
  in the other sectors.
• 30:12
  So people stay at home in their villages or
• 30:16
  have gone back to their villages into, you know, overcrowded farms.
• 30:23
  It's not that the farm sizes are that big to afford everyone a livelihood.
• 30:27
  And so it's actually a sign that we're not producing enough good jobs.
• 30:34
  >> Jon Hartley: Interesting.
• 30:35
  That's fascinating.
• 30:37
  And for our viewers here, definitely recommend checking out Rajan's book,
• 30:43
  Breaking the More India's Untraveled Path to Prosperity.
• 30:48
  It's fascinating just to think about economic growth in India and elsewhere and
• 30:53
  all these market reforms that transpired over the late 20th century and
• 30:57
  there's a paper by Andre Schleifer that sort of describes this period as
• 31:02
  the age of Milton Friedman.
• 31:04
  And it's interesting to think about the legacy of many of these market reforms
• 31:09
  now, many years later, and some of the effects of of these things.
• 31:13
  It's a research interest of mine that I think is very interesting and
• 31:16
  some of these microforms, obviously, are somewhat more controversial than others.
• 31:21
  But it's something that I think began in the 70s and
• 31:26
  80s and really touched many, many countries.
• 31:30
  And now we're in a world where growth looks very different than it once was.
• 31:36
  But there's still even though there has been a considerable amount of
• 31:40
  convergence in maybe the past,
• 31:43
  in the couple decades leading up to Covid, I think it's not totally clear
• 31:48
  that we're still on a path to convergence in the post Covid years here.
• 31:53
  I want to talk just a little bit about an old book, actually,
• 31:57
  that you wrote a book in 2003.
• 32:00
  Titled Saving Capitalism from the Capitalists you wrote with Luigi Zingales.
• 32:04
  I'm curious, 20 years later, how do you think it's held up?
• 32:07
  And you've written quite a bit recently on this topic of riskless capitalism.
• 32:13
  I'm curious what you mean by that.
• 32:15
  >> Raghuram Rajan: So we wrote that book worried about cronyism and
• 32:21
  saying that both George Stigler and
• 32:25
  Karl Marx were worried about the same thing,
• 32:31
  business being in bed with the government.
• 32:37
  And if there was a problem with capitalism,
• 32:41
  it was primarily that working to both stifle competition but
• 32:46
  also promoting authoritarianism.
• 32:50
  When they were in bed together, of course they had very different solutions.
• 32:55
  Stigler's solution can be caricatured as get rid of the government.
• 32:59
  And Karl Marx was get rid of the business and let government run everything.
• 33:06
  They're caricatures, but I think that the problem still remains.
• 33:12
  And we're seeing it in the United States today, that big business being very,
• 33:19
  very closely in bed with government on so many dimensions.
• 33:25
  We're also seeing the revival of industrial policy
• 33:30
  where government decides it has all the foresight needed to pick winners.
• 33:38
  And you know, coming from a country,
• 33:41
  Luigi coming from Italy, I coming from India,
• 33:45
  where we saw the dangers of these kinds of policies,
• 33:50
  we were trying to argue in that book that that one,
• 33:55
  it was very problematic when that happened.
• 33:59
  And second, that the only surefire way of creating a pro-competitive
• 34:06
  environment was openness, including trade openness.
• 34:13
  It was competition from the people you don't control that keeps
• 34:17
  cronyism under check because you know so long as you're open or
• 34:22
  forced to be open, your people have to compete with the rest of the world.
• 34:28
  Of course we were aware, but we didn't anticipate the extent
• 34:33
  to which there would be a movement to closing down the borders and to protect.
• 34:42
  Given how we had seen how bad that could be in our economies,
• 34:48
  we thought the US would not move in that direction.
• 34:54
  We certainly there have been other forces
• 34:58
  which have moved us in that direction.
• 35:03
  I think primarily the force of technology.
• 35:06
  Technological change, as always, has been huge.
• 35:10
  And people blame the loss of middle-income jobs to globalization.
• 35:15
  But as you know, most economists would say the bigger factor is technological
• 35:21
  change and that's killed a lot of middle income jobs, creating the reaction.
• 35:27
  And that reaction to some extent has been deflected towards globalization.
• 35:32
  I think globalization bears only part of the blame.
• 35:36
  And what we've done as a result is created the environment where everything
• 35:40
  closes down.
• 35:43
  And that I think will serve us very, very poorly.
• 35:47
  >> Jon Hartley: When you write about riskless capitalism, I'm curious,
• 35:50
  what do you think about bailouts?
• 35:52
  And not just bailouts per se, but I think thinking back to 2008 and
• 35:58
  sort of the pre 2008 era versus the post,
• 36:01
  I think there is a greater reflexivity on the part of policymakers to intervene,
• 36:07
  whether it's more quantitative easing or whether it's some sort of like,
• 36:13
  you know, say, dovish monetary policy signal,
• 36:16
  if there's some sort of disruption in financial markets.
• 36:21
  >> Raghuram Rajan: Yeah, I mean- >> Jon Hartley: Right, say the put,
• 36:25
  the Powell put, you name it, or even when you think the 2020, 2021 response.
• 36:32
  It seems to me like it's trying to not only put out all fires,
• 36:37
  but prevent any fires from possibly ever coming up again.
• 36:43
  And I don't know if that's something that I think sort of at some level there has
• 36:47
  to be some fires, there has to be some risk taking.
• 36:50
  That's just part of the nature of capitalism, part of the economy.
• 36:53
  I'm curious, do you think there is a moral hazard risk there?
• 36:57
  >> Raghuram Rajan: So there are two kinds of riskless capitalism, right?
• 37:00
  One is where you take out the capital upfront,
• 37:04
  which is practiced by a number of entrepreneurs across the world,
• 37:09
  and you run the enterprise on somebody else's money, right?
• 37:14
  A second related, you run it on a very thin layer of equity.
• 37:21
  But you also depend a lot on public intervention to
• 37:26
  bail you out when things go wrong.
• 37:31
  I think that the west suffers more from
• 37:36
  the latter right now that risk taking.
• 37:42
  And I would say, when I say the West,
• 37:45
  I think Europe is much more concerned about the downside risks and
• 37:50
  tends to regulate in such a way that you really also eliminate the upside.
• 37:55
  But it's perfectly willing to intervene when,
• 37:59
  despite all the regulation, bad things still happen.
• 38:03
  I think in the US there's more of a tolerance for
• 38:07
  downside risk in the hope that it will create some upside.
• 38:11
  So for example, the willingness to let crypto currencies run
• 38:16
  wild without regulating them, hoping that maybe there's some
• 38:21
  technological development there which makes us all better off.
• 38:26
  But I think the flip side of this is that the US has become
• 38:31
  much more willing to intervene in order to protect
• 38:36
  the broader mass of people against the downside.
• 38:41
  And some of this may have to do with also the fractures in society that
• 38:46
  we see that people are angry as it is and you don't want them to get much angrier.
• 38:52
  So we saw the repeated sort of transfers to households,
• 38:58
  but also to small firms during the pandemic.
• 39:03
  And some of those transfers to small firms went straight back to their banks.
• 39:08
  And so the banks which should have taken a hit because of,
• 39:11
  you know, bad stuff happens occasionally.
• 39:15
  Actually saw their loan losses go down during the pandemic.
• 39:19
  And we also saw 2023, March 2023, perhaps the most
• 39:25
  expensive bank crisis in terms of assets that failed over 900 billion.
• 39:32
  But also hugely important in the extent of intervention.
• 39:37
  Effectively, the Fed and
• 39:38
  the treasury combined to say all uninsured deposits are now insured.
• 39:44
  And when that happens, as you correctly put does suggest to
• 39:49
  people who signed up to a contract that they would take
• 39:53
  the risk of putting their money in an uninsured way,
• 39:57
  that if they did it in sufficient mass, they would all be bailed out.
• 40:05
  I don't think we've seen the last consequence of all this.
• 40:09
  The one immediate consequence was the public thought it wasn't a big deal.
• 40:15
  Nobody is paying attention to the big crisis of 2023.
• 40:18
  They call it a mini crisis because of the massive intervention that took place.
• 40:25
  Now what that means is that a bunch of players in the market know that when
• 40:30
  liquidity gets tight, the Fed will come in with all guns blazing and
• 40:36
  may alter contracts also in a way as to protect the system.
• 40:41
  Will Lehman ever happen again?
• 40:44
  Not if the Fed can help it.
• 40:46
  Because the lesson from Lehman is never again and not so much.
• 40:51
  Okay, we need the regulations to make sure that Lehman doesn't really happen.
• 40:57
  I'm not saying we need a whole lot of new regulations.
• 41:02
  I'm saying that we need to make sure that we are regulating reasonably
• 41:09
  given the kinds of interventions that the system has come to expect.
• 41:16
  Otherwise, this is a one-way street, heads I win, tails the public loses.
• 41:22
  And that is another version of riskless capitalism that I think we've engendered.
• 41:27
  Especially for the people taking big bets in the system.
• 41:31
  Big financial bets in the system.
• 41:34
  >> Jon Hartley: Absolutely, yeah, 2023, I think we still don't
• 41:39
  fully understand what the consequences of it really are in terms of if
• 41:46
  de facto all deposits are really actually insured versus not.
• 41:52
  There's still, I think, quite a bit to be figured out in terms of what
• 41:57
  deposit insurance is and what its limits are in the US.
• 42:01
  Very fascinating hearing about your thinking around riskless capitalism.
• 42:05
  And a real honor to have you on Raghu and hear about your career and ideas.
• 42:09
  Thank you so much for joining us.
• 42:11
  >> Raghuram Rajan: Thank you, Jon, it's a pleasure being with you.
• 42:14
  >> Jon Hartley: This is the Capitalism and Freedom in the Twenty-First Century
• 42:16
  podcast, an official podcast of the Hoover Economic Policy Working Group,
• 42:19
  where we talk about economics, markets, and public policy.
• 42:22
  I'm Jon Hartley, your host, thanks so much for joining us.
• 42:24
  [MUSIC]