Raghuram Rajan, former Chief Economist at the International Monetary Fund (IMF) and former RBI Governor has urged central banks globally to raise their intervention thresholds. This recommendation comes in the wake of Jerome Powell’s speech at Jackson Hole.

What Happened: Rajan praised the U.S. Federal Reserve’s success in curbing inflation, which fell from 9% in June 2022 to under 3% in the following month, in a recent opinion piece in Financial Times. Despite this, he cautioned about potential risks, especially those associated with the ongoing inflation in services and housing.

Rajan shed light on the effects of the pandemic and the Ukraine war on supply and demand, leading to inflation. He observed that most of the disinflation happened naturally, without the influence of the Fed.

Rajan also mentioned that despite the Fed’s attempts to control demand, sectors like automobiles have seen a rise in sales since the central bank started increasing rates. He attributed this to the expansion in supply in the U.S. economy due to immigration and productivity enhancements.

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However, Rajan expressed apprehension over the financial sector’s leverage, which hasn’t significantly reduced despite the efforts of central banks. He cautioned that economic stabilization could ironically heighten the risk of financial instability.

“None of this, of course, is to suggest that central banks should engineer an economic downturn to cleanse the financial system. It does mean, however, that they should raise the bar on intervening whenever it gets into trouble. As with forest fires, small conflagrations can prevent a larger one,” Rajan concluded.

Why It Matters: Rajan’s comments come at a time when central banks globally are grappling with the after-effects of the pandemic. In August, Powell hinted at potential interest rate cuts in September while the European Central Bank held interest rates steady, keeping markets guessing.

Meanwhile, the Bank of Japan is expected to delay further interest rate hikes until 2025, prioritizing market stability.

In a recent survey, central bank reserve managers identified geopolitical conflicts as the main threat to the global economy, driving diversification of investments across different regions and currencies.

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Image created using artificial intelligence via MidJourney.

This story was generated using Benzinga Neuro and edited by Pooja Rajkumari