The former governor of the Reserve Bank of India talks about his return to teaching, the imperfect world of policymaking and how scholarship is ‘as close to bliss as you can get.’
After three years as India’s top central banker, Raghuram Rajan has returned to his longtime home at the University of Chicago Booth School of Business as the Katherine Dusak Miller Distinguished Service Professor of Finance.
Rajan, who first joined Chicago Booth in 1991, was governor of the Reserve Bank of India from 2013 to September 2016. He served as the chief economist and director of research at the International Monetary Fund from 2003 to 2006.
Chicago Booth recently spoke to Rajan at his office on the Booth campus in Hyde Park. An edited transcript follows. For highlights of the conversation, watch the video here.
CHICAGO BOOTH: Welcome back to the University of Chicago, Professor Rajan. How does it feel to be back in Chicago?
PROFESSOR RAJAN: This has been my home for 25 years. It's a great city. I have great colleagues. And it’s a wonderful school. It's different every time you come back. If it wasn't different, it wouldn't be doing its job.
CB: What are you most looking forward to most as you return to academic life?
RAJAN: One of the difficulties of a job in the quote ‘real world’ is you don't really get time to shut yourself off in a room and think. Now in academia, if you're not too careful, you get really dragged into the real world and you don't have that time. But if you are careful, you can spend four days in a room, sit looking at a piece of paper and struggling with a thought that refuses to come out. At the end of those four days, sometimes, you say, ‘Oh my God, how did I miss this?’—and it dawns on you. And that's as close to bliss as you can get.
CB: What will be the focus of your research now that you're back in academia?
RAJAN: Research never really leaves you. You're always thinking about problems. You're looking at practical problems that you face and thinking about how you would get a different angle on it. While I was at the Reserve Bank (of India), I published some papers, but you don't get time to really reflect.
I'm interested in a number of issues that I was interested in before I left, but of course you are influenced by the real world. And what we see out there is a strengthening of populist movements around the world. You see some concerns about the market. Is the free market really what we want to have as a society?
In an era of widespread democracy you cannot have a system which works only for some, and not for others. The markets need political support. We need to further that debate. And Chicago has always played an important role in that debate. We need a better solution, and that is part of what I hope to think about.
CB: in August 2005 at the annual gathering of economists and policymakers from around the world in Jackson Hole, Wyo., you delivered a paper, “Has Financial Development Made the World Riskier,” that very famously warned of a looming financial crisis. Nobody wanted to hear the warning at the time. But it turned out to be quite prescient. What do you see happening now? Is financial risk and growing debt still a big problem?
RAJAN: The truth is economists aren’t able to really see into the future. What you can do is look at a bunch of patterns that are emerging, and point to the risks that something bad could happen. But you're never certain. I can't say that I was not surprised by what happened in 2008. Yes, I had talked about some of the factors that were leading up to that, but the extent of the damage that was done in financial markets, to financial institutions, to confidence, and more broadly to trust in markets was far greater than anyone could have imagined.
Are the problems solved? Are we moving forward? Have we put behind us financial fragility? The sad answer is no. We have made progress. Banks are much better capitalized than they were, there is much more of a sense that incentives left to themselves sometimes can create public risk. And we need to think about how that works. But there are also areas of the financial sector that we have left relatively lightly-regulated, even while we are putting regulation after regulation on the parts we understand better. And to my mind uneven regulation is as much of a problem as no regulation or excessive regulation--because uneven regulation leads to regulatory arbitrage. Activity moves from the regulated part to the unregulated part. And this is where the worry is. The one big lesson from the crisis is everything is connected, so (if you) make this safe, make that unsafe, you're not safe yet.
CB: Okay, so does that lead to particular areas of research that you want to dig into?
RAJAN: The global financial crisis essentially gave us research topics for the next 30 years. If you look at what happened, there are about 15 to 20 different stories now emerging. I would argue that one of the biggest factors was a large amount of liquidity in financial markets, which tends to breed complacency. Actually (Chicago Booth Prof.) Doug Diamond and I have a paper on that now (National Bureau of Economic Research work paper, Pledgeability, Industry Liquidity, and Financing Cycles, January 2017).
More liquidity means more leverage. More leverage means more financial fragility. That complacency comes back to hit us in down times, and then the down times take a long time to get out of, because we're still rebuilding the mechanisms that we shouldn’t have let go of in the good times. This is a fertile area for research—the increasing inequality, as well as the sort of leverage we built up in an attempt to deal with problems like inequality.
CB: What’s the difference between your job as a scholar, in which you’re giving all sorts of advice to policy makers, as you did with the Jackson Hole paper, and actually being a policy maker and having all this advice thrown at you?
RAJAN: As a policy maker, you're desperate for more data to guide your policy making. You would love to have a ton of research telling you, ‘this works, that doesn't, thus and such is how you should go.’ But, in practice, you don't have it. So you're going 60 miles per hour with the rain pattering on your windshield, and the windshield is fogging up. And you're on a highway, so you can't stop, because you could cause a pile-up, but you have no idea what's in front of you. That's sort of policy making.
And so you always go back. I found that if I went back to first principles, and thought through the problems, and said ok if this is what is going on, here are the things that will affect the economy. Here's what I don't know, but here's what I broadly know. But you don't get time to really reflect.
CB: How have your experiences as governor of the Federal Reserve Bank of India and as chief economist at the International Monetary Fund affected your approach to teaching Chicago Booth’s International Corporate Finance course this winter?
RAJAN: I am teaching a course I taught before. I always made it a point to change two or three cases every year, so at the end of five years, the course would be quite different. That’s true this year also.
The course is on international corporate finance, but there's a fair amount of thinking about the political environment, about the strategic/political decision making, when you're making large investments in emerging markets, in countries around the world. I hope it introduces the nuances in other countries to our students. Clearly we can't go to every country in the world and see what's different. But what I do want them to understand is not every country works like the United States. Many of them have international experience and know that, and my job really is to bring their collective wisdom into the classroom through cases, so that we can understand how we should approach some of these issues in a country we've never been to.
CB: So let's wrap up with a little history. How did you first become interested in economics and finance? Was there a particular moment or turning point?
RAJAN: I was reasonably interested in math, and a friend told me about econometrics. I had read Isaac Asimov's Foundation series (science fiction novels in which a mathematician develops a formula for predicting the future course of human history) and you're trying to predict how people behave, and I thought well, that's a nice thing. At that time I also started reading about John Maynard Keynes, and the work he had done, and I found it extraordinary. The quick take on John Maynard Keynes was he took the world out of depression. Now that's not quite correct, but certainly his ideas were very influential in post-war economics— both in creating the Bretton Woods system (of monetary management), but also in the Keynesian approach to dealing with business cycles. It seemed to me that here was a person who through the strength of his ideas is changing the way we think. That's extraordinary, and I wanted to be like him.
CB: Any other plans now that you are back in Chicago?
RAJAN: It's a great city, and we're now in the middle of winter, but every, so often it delights you with a beautiful day. Taking my bike out and riding the bike path along Lake Shore Drive, that's one of the great experiences in my life. And I hope to do it as long as I can. It's great to be back.