Seven years ago, as a sovereign debt crisis was unfolding in the European Union (EU), the president of the European Central Bank (ECB), Mario Draghi uttered these famous words: “The ECB is ready to do whatever it takes to preserve the euro." This was like an open-ended, no-holds-barred promise to investors that the ECB was determined not to let the unified currency unravel, or let the Eurozone economy deteriorate further. His words hinted at an unlimited arsenal with unimaginable powers to rescue the Eurozone. Within a week of that speech, the ECB also announced its version of quantitative easing, called “outright monetary transactions", wherein it promised to buy sovereign bonds of fiscally distressed countries like Greece. The ECB never had to redeem that promise. Sovereign bond markets calmed down. Just the promise of “whatever it takes" was enough. The threat to the euro, posed by a wide divergence of yields between sovereign bonds, subsided.

What is the lesson from this “whatever it takes" episode? That central bankers can play God? That “open mouth operations" are effective? That a mere word from an oracle is enough to turn the tide? It might have fended off the euro crisis temporarily, but the Eurozone’s longer term problems remain—nay, have worsened. Despite a weaker euro vis-a-vis the US dollar for nearly a decade, its exports and economic growth are still weak. Its largest economy, Germany is in recession, and its exports have suffered. Even as Draghi steps down this year, there is talk of further easing and more quantitative easing. The ECB has pushed the envelope in saying that it will buy even non-sovereign junk bonds to keep yields low or negative.

In the past ten years, the balance sheets of the US Federal Reserve, ECB, Bank of England and Japan’s central bank have all expanded by more than 400%, and their monetary policy has been extremely loose. But they have little to show in terms of a substantial rise in real investment, high-productivity jobs or sustainable economic growth. Wages have stagnated, as have median household incomes, while income and wealth inequality have increased and populists have been voted in. Financial firms have raked in profits, but surely that’s not what the ECB or the Fed intended. Last week’s Long Story in Mint, “The last stand of the central banker" by V. Anantha Nageswaran, pointed out that central banks have run out of ammunition. Further, not only was the medicine of loose monetary policy not working, it may have led to nasty side effects like rising inequality.

It’s worth recalling the limited potency of “whatever it takes" in light of the Reserve Bank of India’s monetary policy statement on 4 October. RBI has had to drastically reduce its estimate of growth for this year. It said business conditions based on its own index were as bad as in 2008. Financial flows from banks, non-banks and capital markets to the corporate sector had collapsed. Hence, the governor said that policy would remain accommodative till growth returned. This is not quite “whatever it takes", but does sound like an unlimited promise. There is already pressure on RBI to buy non-sovereign paper or bail out NBFCs. How far will its accommodation go? Who’s to say when growth returns? Two, three or four quarters? Or does RBI believe that a mere promise will soothe the nerves of risk-averse investors and real investment will pick up? It has already rewarded the Centre with a huge unbudgeted dividend. The fiscal deficit is almost 85% de facto monetized, as those bonds reside with RBI. Unprecedented times call for unprecedented policy action. But there are limits to what RBI can achieve in the current situation. What is worrisome is that a further lowering rates can make matters worse. Household debt, most notably credit card receivables, have grown at a whopping 30%, contributing to the fall in household savings. Lower interest rates may spur credit card binges and possibly blow a bubble in consumer credit. The savings decline, income stagnation and sluggish demand mean very little private-sector investment. The benefits of cheaper credit will be erased by these costs, not to mention the dichotomy of high administered rates on small saving. And the growing fiscal deficit is a looming shadow that keeps the rate on risk-free debt from softening. So “whatever it takes" or any such promise should be made very carefully. Of course, RBI itself has a successful precedent: in November 2008, it assured funds to mutual funds hit by panic redemptions. “Whatever it takes’ never had to be invoked, since the panic stopped the moment RBI promised assistance. The central bank’s credibility is a precious and potent weapon, to be used very sparingly in assuring markets and investors. No doubt, a rescue of growth needs an accommodative monetary policy, but the heavy lifting has to come from other quarters, not just RBI.

Arvind Subramanian, in his recent book, describes a dream where he single-handedly has to defend the transfer of excess capital out of RBI against a pantheon of formidable former RBI governors. Public opinion is against him; he is accused of being a finance ministry lackey; and how dare he destroy a great institution like RBI? But then, its balance sheet is too bloated, he says, and suddenly Governors Ben Bernanke and Draghi appear. The debate is a no-brainer, they pronounce, and one should obviously do “whatever it takes". But that, remember, was just a dream sequence.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution

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