In a recent speech at a Mumbai think tank, Reserve Bank of India Governor Raghuram Rajan emphasised the detrimental impact of quantitative easing (QE) and 'extreme' monetary policies adopted by the central banks of advanced economies on emerging economies. The impact on domestic growth in economies that follow these policies, he claimed, has just not been enough to offset the negative impact abroad. Thus for the world economy the glut of money has been a net negative.
His observations come at moment when there is a curious divide in the policy world yet again over the efficacy of these measures. The European Central Bank (ECB) is under pressure to increase the quantum of monetary infusion from its ^1.1-trillion package that it introduced in March. Somewhat fuzzy rumours of a fourth QE programme in the US have also been doing the rounds. While Rajan and many others are likely to consider all this a terrible idea, it has its band of cheerleaders.
Rajan does have a point. The US economy that showed much promise earlier this year seems to be losing steam. After the non-farm payroll (jobs) numbers were released earlier this month, many in the US are forecasting an anaemic recovery at best. Both wholesale and retail sales have been dipping and inventories are building up. Exports too are falling rapidly. With the US Federal Reserve still pussyfooting about its first rate hike in almost 10 years, the Fed's critics wonder what the fuss is all about? What did this prolonged period of easy money really get us?
A new report by the Group of 30 - an international body led by former ECB chief Jean-Claude Trichet - makes an interesting distinction. It says that while QE and other "extraordinary" measures may have succeeded in stabilising markets in the aftermath of the 2008 financial crisis, they have been ineffective in restoring growth and reducing unemployment. In fact, these measures may have become semi-permanent as stronger demand growth has remained elusive.
Those critical of QE have also pointed out that it has only benefitted the top 20 per cent of households by keeping asset prices high and rising. The flow of easy money has inflated asset prices like stocks and housing without having any real impact on stimulating economic growth.
The pro-QE camp spins the recent US data around to make a case that easy money did work well. Narayana Kocherlakota, the president of the Minneapolis Federal Reserve, has suggested that the current moderation in US economic growth is the result of the phasing out of QE in 2013, which is having a lagged impact. His point seems to be that large amounts of liquidity infusion indeed did the trick in propping up growth; in fact, its premature withdrawal is visible in the discouraging data over the last couple of months.
The Minnesota Fed boss' prescription represents those in the easy money campers. He rules out an increase in the US policy rate not only in 2015 but also in 2016. He also goes a step beyond old fashioned QE and advocates negative interest rates, a measure that the ECB experimented with earlier by charging a bank money to park deposits with itself. This works through the so called 'hot potato' effect where instead of paying to keep their money at the central bank, they would lend to consumers and businesses.
The idea that monetary policy is the only policy tool available to policy-makers is so deeply entrenched that it will continue to be used extensively by Western economies in the foreseeable future. The current dogma is that fiscal policy is a no-no as it creates more debt for governments. Structural reform that some economists love to prescribe takes a long time to work itself through the system. Thus pouring in more liquidity into economies seems to be the default option. Expectations of further liquidity easing in Europe have started to drive a rally in emerging markets. Their currencies are appreciating again. It is now up to monetary policy managers in the emerging world to control the collateral damage. Life isn't fair, is it?
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is principal economist, CII
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