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Raghuram Rajan’s prediction: Great Depression-like Problems loom; Explanation

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The RBI governor is famous all over the world for being one of the few who predicted the 2008 financial crisis. Now he is again sounding alarm bells saying that the global economy may be slipping into problems similar to the Great Depression of the 1930s.

The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in 1930 and lasted until the late 1930s or middle 1940s

He said that “It’s not just a problem for the industrial countries or emerging markets, now it’s a broader game”.

Why does he think so: Crux of Rajan’s message

  • After the stock market crashed in October 1929, which started the depression, to stop contraction of their economic growth, countries tried to solve this problem by devaluing their currencies against other currencies in order to increase their international competitiveness.
  • By devaluing a currency they tried to make exports competitive but imports became expensive. But soon all countries started devaluing their currencies leading to more problems for everyone.
  • Presently, countries around the word as printing more and more money(also called Quantitative easing in US) and giving it to their people as loans so that they would invest it and create jobs. However printing money also devaluates currency and increases exports.
  • Now, as done in the past, now every country is in the race to print more money and devalue their currency to keep their exports competitive.
  • The US has started the Quantitative easing, devaluing its dollar. Then Japan followed, its Yen has been devalued to a 30 year low against the dollar. With this, China is thinking of devaluing Yuan/ Renminbi and South Korea its Won, to stay competitive against Japanese Yen. If China devalues its currency, then its imports from developed countries would reduce as the import of foreign good would become costly for Chinese consumers to buy.
  • This leads to depression for developed countries as China is not buying their goods

What needs to be done:

  • Raghuram Rajan has asked central banks from across the world to define “new rules of the game” through international discussion, international consensus built over time after much research and action
  • Countries must think about the consequences of their competitive monetary policy easing by their central banks to activate growth