## Less Is More

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**Canonical URL:** [Less Is More](https://www.imf.org/en/publications/fandd/issues/2023/03/central-banks-less-is-more-raghuram-rajan)

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## Bibliographic details
- Authors: RAGHURAM RAJAN
- Published: March 1, 2023

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### Thesis and overview
- More focused, less interventionist central banks would likely deliver better outcomes.
- Central banks should refocus on their primary mandate of combating high inflation while respecting a secondary mandate of maintaining financial stability.

### Case for central bankers
- Pandemic and unexpected shocks:
  - The pandemic was unprecedented and its consequences for the globalized economy very hard to predict.
  - Vladimir Putin went to war in February 2022, disrupting supply chains and sending energy and food prices skyrocketing.
- Frameworks and beliefs constrained action:
  - The Federal Reserve changed its framework during the pandemic to be less reactive to anticipated inflation and keep policies more accommodative for longer.
  - That framework was appropriate for an era of structurally low demand and weak inflation but was ill-suited as inflation began to rise.
- Political legitimacy limitations:
  - With governments having spent trillions to support economies, employment recovering from terrible lows, and inflation barely noticeable for over a decade, preemptive rate rises lacked public legitimacy.
- Summary point:
  - Central bank hands were tied by recent history, adopted frameworks that favored accommodation, and the politics of the moment.

### Case against central banks
- Fiscal and financial dominance emerged:
  - Long periods of low interest rates and high liquidity prompted increases in asset prices and leveraging across government and private sectors.
  - Central banks bought government debt financed by overnight reserves, shortening the maturity of financing for governments and central banks’ consolidated balance sheets.
  - Fiscal considerations already weigh on some central banks (example: the European Central Bank and concerns about “fragmentation”).
- Private sector leverage and liquidity dependence:
  - Commercial banks financed reserves largely with wholesale demand deposits, shortening the maturity of their liabilities.
  - Banks wrote liquidity promises (committed lines of credit, margin support) that are hard to unwind as central banks shrink balance sheets.
  - UK pension turmoil in October 2022 illustrated liquidity-dependent private sector dynamics, defused by central bank intervention and government backtracking.
- Asymmetric central bank action and distributional costs:
  - Central banks may be quicker to ease policy when asset prices fall but more reluctant to tighten when asset prices bubble, following a long-standing asymmetry.
  - High asset prices and subsequent losses when prices normalize can harm households, pension funds, and the relatively poor.
- External spillovers:
  - Policies of core reserve countries affect the periphery via capital flows and exchange rates, forcing periphery central banks to react even if actions are unsuitable domestically.
- Summary point:
  - Central banks’ past unconventional and asymmetric policies contributed to imbalances that constrained their ability to fight the higher-inflation regime.

### Mission creep and mandates
- Limits of expanding central bank roles:
  - Central banks are not the obvious institutions to combat climate change or promote inclusion; often they have no mandate to do so.
  - Central bank tools have limited effectiveness in areas like climate change or inequality and may influence effectiveness on primary mandates (example: inclusion focus potentially holding back rate increases).
  - Directly combating climate change or inequality is best left to elected governments.
- Regime-dependent framework contradiction:
  - Low-inflation regime: may require commitment to being more tolerant of inflation to raise inflation (Paul Krugman’s “rationally irresponsible” idea).
  - High-inflation regime: requires strong commitment to eradicate inflation early—“when you stare inflation in the eyeballs, it is too late.”
  - A framework that credibly commits in one regime may undermine commitment in the other; central banks cannot easily shift frameworks without losing commitment power.

### Choosing frameworks and financial stability
- Recommended emphasis:
  - Reemphasize the mandate to combat high inflation using standard tools such as interest rate policy.
  - If inflation is too low, tolerate it unless it collapses into a deflationary spiral; avoid tools like quantitative easing that distort credit, asset prices, and liquidity and are hard to exit.
- Financial stability role:
  - Central banks may need a stronger mandate to help maintain financial stability because prolonged low inflation episodes can follow financial crises and monetary tools contribute to asset-price-driven leverage.
  - Macroprudential supervision remains important but has been insufficient so far; better coverage of the nonbank shadow financial system is needed.
  - Monetary policy “gets into all the cracks” and with that power should come some responsibility.
- External dialogue on spillovers:
  - A dialogue on spillovers should begin at the BIS in Basel and then involve the IMF and government representatives to discuss central bank mandate changes in an integrated world.
- Summary point:
  - Refocusing central banks on combating high inflation and maintaining financial stability will likely produce fewer spillovers and better outcomes.

### Policy recommendations and concluding assessment
- Principal recommendations:
  - Refocus central banks on primary mandate of combating high inflation.
  - Respect secondary mandate of maintaining financial stability, including better macroprudential coverage of the financial system and attention to the nonbank shadow sector.
  - Avoid expanding mandates into climate change and inequality; leave direct action to elected governments while assessing implications of these issues for monetary and financial stability objectives.
  - Promote apolitical international dialogue (BIS, then IMF) on spillovers and possible mandate adjustments.
- Final assessment:
  - More focused and less interventionist central banks would probably deliver better outcomes than the high-inflation, high-leverage, low-growth world described.
  - For central banks, less may indeed be more.

*Raghuram Rajan, "For Central Banks, Less Is More", F&D Magazine, March 2023.*

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## Content in this bundle

- **F&D March 2023: Central Banks; Less is More**
  - [F&D March 2023: Central Banks; Less is More (Markdown version)](/-/media/files/publications/fandd/article/2023/march/rajan-central-banks-less-more.pdf.md){rel="alternate" type="text/markdown"}
  - [F&D March 2023: Central Banks; Less is More (PDF)](/-/media/files/publications/fandd/article/2023/march/rajan-central-banks-less-more.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/fandd/issues/2023/03/central-banks-less-is-more-raghuram-rajan_