Decoding Rajan’s Frankfurt speech: Why central banks fuel bubbles

 ARTS RAJANVivek Kaul  

Alan Greenspan, when he was the chairman of the Federal Reserve of United States, the American central bank, used to say “I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant.”
Greenspan was known to talk in a very roundabout manner, never meaning what he said, and never saying what he meant. Thankfully, all central bank governors are not like that. There are some who like calling a spade a spade.
Raghuram Rajan, the governor of the Reserve Bank of India(RBI), was in Frankfurt yesterday to receive the 
Fifth Deutsche Bank Prize for Financial Economics. In his speech he said things that would have embarrassed central bank governors of the Western nations, who are busy printing money to get their economies up and running again.
In the aftermath of the financial crisis that started in late 2008, Western central banks have been printing money. 
With so much money going around, the hope is that interest rates will continue to remain low (as they have). At low interest rates people are likely to borrow and spend more. When they do that this is likely to benefit businesses and thus the overall economy.
But what has happened is that the citizens of the countries printing money are still in the process of coming out of one round of borrowing binge. When interest rates were at very low levels in the early 2000s, they had borrowed money to speculate in real estate in the hope that real estate prices will continue to go up perpetually. This eventually led to a real estate bubbles in large parts of the Western world.
Eventually, the bubbles burst and people were left holding the loans they had taken to speculate in real estate. Hence, people who are expected to borrow and spend, are still in the process of repaying their past loans. So, they stayed away from taking on more loans.
But money was available at very low interest rates to be borrowed. Hence, banks and financial institutions borrowed this money at close to zero percent interest rates and invested it in stock, real estate and commodity markets all around the world. Some of this money also seems to have found its way into fancier markets like art. And this has again led to several asset bubbles in different parts of the world. As Rajan put it in Frankfurt “
We seem to be in a situation where we are doomed to inflate bubbles elsewhere.”
Economists still do not agree on what is the best way to ensure
 that there are no real estate or stock market bubbles. But what they do agree on is that keeping interest rates too low for too long isn’t the best way of going about it. It is a sure shot recipe for creating bubbles. Even the once great and now ridiculed “Alan Greenspan” agrees on this. In an article for the Wall Street Journal published in December 2007(after he had retired as the Fed chairman), he wrote “The 1% rate set in mid-2003…lowered interest rates…and may have contributed to the rise in U.S. home prices.”
What he was effectively saying was that by slashing the interest rate to 1%, the Federal Reserve of United States may have played a part in fuelling the real estate bubble in the United States. Rajan in his Frankfurt speech for a change agreed with Greenspan. As he said “
We should wonder whether lower and lower interest rates are in fact part of the problem, I say I don’t know.”
It is easy to conclude from the statements of Greenspan as well Rajan that central bank governors do understand the perils of printing money to keep interest rates low. Given that why are they still continuing to print money? Ben Bernanke, the current Chairman of the Federal Reserve hinted in May 2013, that the Fed plans to go slow on money printing in the months to come. He repeated this in June 2013. But when the Federal Reserve met recently, nothing happened on this front and it decided to continue printing $85 billion every month.
As Albert Edwards of Societe Generale put it in a February 2013 report titled 
Is Mark Carney the Next Alan Greenspa…? I keep seeing Central Bankers saying again and again that QE(quantitative easing, a fancy term for printing money) and more recently, helicopter money is not only necessary but essential.”
So the question is why do central banks in the Western world continue to print money? Dylan Grice, formerly of Societe Generale, has an answer in his 2010 report 
Print Baby Print. As he writes “What’s interesting is that central banks feel they have no choice. It’s not that they’re unaware of the risks…They’re printing money because they’re scared of what might happen if they don’t. This very real political dilemma… It’s like they’re on a train which they know to be heading for a crash, but it is accelerating so rapidly they’re scared to jump off.”
Sometimes the withdraw symptoms are so scary that it just makes sense to continue with the drug. Dylan compares the current situation to the situation that Rudolf von Havenstein found himself in as the President of the Reichsbank, which was the German central bank in the 1920s.
Havenstein printed so much money that it led to hyperinflation and money lost all its value. The increase in money printing did not happen overnight; it had been happening since the First World War started. By the time the war ended, in October 1918, the amount of paper money in the system was four times the money at the beginning of the war. Despite this, prices had risen only by 139%. But by the start of 1920, the situation had reversed. The money in circulation had grown 8.4 times since the start of the war, whereas the wholesale price index had risen nearly 12.4 times. It kept getting worse. By November 1921, circulation had gone up 18 times and prices 34 times. By the end of it all, in November 1923, the circulation of money had gone up 245 billion times. In turn, prices had skyrocketed 1380 billion times since the beginning of the First World War.
So why did Havenstein start and continue to print money? Why did he not stop to print money once its ill-effects started to come out? Liaquat Ahamed has the answer in his book The Lords of Finance. As he writes “were he to refuse to print the money necessary to finance the deficit, he risked causing a sharp rise in interest rates as the government scrambled to borrow from every source. The mass unemployment that would ensue, he believed, would bring on a domestic economic and political crisis.”
The danger for central bank governors is very similar. If they stop printing money then interest rates will start to go up and this will kill whatever little economic growth that has started to return. Hence, the choice is really between the devil and the deep sea.
As far as Rajan is concerned he is possibly back to where it all started for him. The Federal Reserve Bank of Kansas City, one of the twelve Federal Reserve Banks in the United States, organises a symposium at Jackson Hole in the state of Wyoming, every year.
The 2005 conference was to be the last conference attended by Alan Greenspan, as the Chairman of the Federal Reserve. Hence, the theme for the conference was the legacy of the Greenspan era. Rajan was attending the conference and presenting a paper titled “Has Financial Development Made the World Riskier?
Those were the days when Greenspan was god. The United States was in the midst of a huge real estate bubble, but the bubble wasn’t looked upon as a bubble, but a sign of economic prosperity. The prevailing economic view was that the US had entered an era of unmatched economic prosperity and Alan Greenspan was largely responsible for it.
Hence, in the conference, people were supposed to say good things about Greenspan and give him a nice farewell. Rajan spoiled what was meant to be a send off for Greenspan. In his speech Rajan said that the era of easy money would get over soon and would not last forever as the conventional wisdom expected it to. “The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis,” said Rajan.
In the last paragraph of his speech Rajan said it is at such times that “excesses typically build up. One source of concern is housing prices that are at elevated levels around the globe.”
He came in for a lot of criticism for his plain-speaking and calling a bubble a bubble. As he later recounted about the experience in his book Fault Lines – How Hidden Fractures Still Threaten the World Economy, “Forecasting at that time did not require tremendous prescience: all I did was connect the dots… I did not, however, foresee the reaction from the normally polite conference audience. I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticized by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what going on before their eyes.”
The situation is no different today than it was in 2005, when Rajan said what he did. The central bank governors are ignoring what is going on before their eyes and that is not a good sign. Or as Rajan put it in Frankfurt “When they (central banks) say they are the only game in town, they become the only game in town.”

The article originally appeared on on September 27,2013

(Vivek Kaul is a writer. He tweets @kaul_vivek) 


About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on and Currently he works as an economic commentator and writes regular columns for He is also the India editor of The Daily Reckoning newsletter published by His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal,,, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at

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