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Fault Lines

INFLATION and economic meltdown are the terms that have dogged us for almost a decade. We have talked animatedly about the alarming increase in price of real estate and the inflationary trends of day-to-day commodities. We have blamed the government for its lax regulatory machinery every time a financial scam raised its ugly head. We have decried corruption, holding it responsible for all ills that ail our society. But perhaps none of us (economic experts included) have really pin-pointed the causes of the economic recession of 2007 that caught the global financial community napping.

Raghuram Rajan’s Fault Lines makes such an analysis with great finesse. Drawing a metaphor from geology, Rajan traces the roots of the global financial crisis to the fault lines created by politics, trade imbalances and the financial structures in place to offset such trade imbalances.

The financial instability is traced back to the late 90s which saw the bursting of the dot com bubble. As the American economy down drastically, the Federal Reserve attempted to stimulate it by reducing the interest rates. This reduction did nothing to improve investments by the corporate sector. Instead, it made easy credit available to a segment of population that had low financial credibility. This segment invested in real estate in a big way but did not have the wherewithal to pay back the loans. So, while property prices soared as never before, the banks ended up holding huge quantities of mortgage-backed securities.

To check this credit expansion and its fall out, an apprehensive Central Bank increased the interest rates, which led to a drastic dip in consumption by the American consumer. This shook the foundations of economies like China which were dependent on American consumption and had invested in import of machinery from Europe to increase production. The Governments of such countries decided to abandon "debt-fueled expansion" and turned from being net importers to net exporters "adding to the global supply glut".

The lesson learnt from the jobless recoveries of the recession of 2001 was also internalised by politicians who attempted to give fiscal and monetary stimulus till the jobs started to reappear. Such a forced stimulus added to the problems of a beleaguered US economy. Weighed down by myriad problems, in 2007, the global economy collapsed. Rajan warns that despite signs of recovery the ‘fault lines’ are still gaping open and would deepen if left unchecked.

For most of us, economic jargon and its nuances are difficult to absorb. But Rajan explains the most complex economic terms in simple language. References to the effect of the crisis on the immigrant Indian Badri or on Jane, who represents the secretarial workforce in the US, adds an element of human interest to a dry subject. What perhaps lends credence to the theories propounded in the book is the fact that Rajan was one of the few economists who cautioned the world against impending economic doom generated by the Greenspan era. A thought-provoking book that adds a new dimension to our understanding of the fractures in global economy.

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