By following a policy of prolonged easy money, the central bankers are artificially boosting current spending hoping that the future generations will pay for consequent, unrealistic growth that may follow now
Short-term thinking has always been the bane of human beings. We are obsessed with events taking place now rather than in the distant future. It is as if the DNA that helps us think and plan for the long term has gone missing. Economists probably suffer more from this ailment than do others. Who can forget John Keynes statement in the context of the depression in the global economy in 1930s that “In the long run we are all dead”?
Well, in the long run we may be all dead. But, we are definitely not entitled to enjoy ourselves at the expense of the future generations. Unfortunately, the easy money policy being pursued the world over, for the past eight years, post the financial crisis, has been doing exactly that. Heads of the central banks the world over probably feel that they are the masters of economic world and it is within their powers to cure any problem, the global economy may face. In the process, saner voices are being ignored, such as that of Dr Raghuram Rajan, the Governor of the Reserve Bank of India (RBI), who has repeatedly in various forums, cautioned against excessive reliance on monetary tools to get the economy back on track. Let us place the problem in the right context.
The irrational exuberance of the early part of this century led to one of the severest financial crisis the world has ever seen. As I had mentioned in one of my earlier articles, the immediate concern when such a crisis strikes is the lack of liquidity in the system, and monetary institutions are ideally placed to provide the requisite liquidity.
Eventually, there is a threat of deflation resulting from the crisis because consumers reduce their spending, leading to contraction in consumption and investment demand. There are two classic responses to improve demand. One is for the government to go on a spending spree, something that was recommended by John Keynes as a solution to the depression of the 1930s. Given that prudence has never been the distinguishing characteristic of governments, not many of them are usually in a position where they can unleash such spending, without significant loss to their credit rating.
The alternative is to use monetary policy to encourage people to spend and companies to invest. The US Fed, the European Central Bank (ECB), and even the Bank of Japan have significantly reduced interest rates since the crisis. When even lower interest proved largely ineffective, the central bankers relied on large-scale purchase of securities to pump money in the economy, popularly called Quantitative Easing (QE).
Evidence suggests that neither lowering of interest rates nor injecting money into the system has proven to be the saviour that the monetary authorities expected. Although growth in the US is back, not many people are convinced of its sustainability. Europe and Japan are of course still mired in a low growth environment. The only saviour until now, China, has now slowed considerably, and has in fact, been the chief cause of the current meltdown in the financial markets.
It would be safe to conclude that the policies being pursued over the last eight years have failed to overcome the impact of the crisis and the global economy is yet to return to the path of growth so urgently required. Historically, recovery from crisis has never taken that long.
Faced with such strong evidence it is natural to change course and adopt alternative policies that may prove to be more effective. Central bankers, however, have concluded that the patient needs a stronger dosage and therefore, have repeatedly increased the extent of their easy money policy. When reduction in interest did not seem to work, the ECB and now the Bank of Japan pushed interest rate into negative territory. When QE1 did not work, the US Fed implemented the QE2 and subsequently the QE3. The ECB has clearly indicated that they are not through with easing monetary policy. The emphasis has only been on ensuring that growth does not slacken over the next few quarters.
Effectively however, the fundamentals of the economy have prevented the regime of easy money resulting in greater spending and investment. Liquidity alone cannot boost inflation if demand is depressed and the propensity to save is high. The prolonged policy of monetary easing has only led to inflated asset prices, stocks as well as bonds, something no one would find easy to justify.
By following a policy of prolonged easy money, the central bankers are borrowing growth and profits from the future generations. In a sense, they are artificially boosting current spending hoping that the future generations will pay for consequent, unrealistic growth that may follow now.
It is high time that the central bankers withdrew and let the economy take its natural course. Policies that are successful, even essential, during times of crisis, need not necessarily succeed in more normal times. They have pursued an extremely easy policy for eight long years without any success in taking the global economy on a path of consistent growth. Having succeeded in overcoming the worst possible outcome of the crisis, they should have withdrawn, letting the economy revive on its own. If that involved temporary pain, so be it. At least, the recovery would have been sustainable and that too without impacting the growth of future generations. Treatments given specifically in ICUs may not be beneficial when the patient returns to the normal hospital bed. Continuing such treatments will only ensure that the patient remains comatose over long periods. The continuation of excessively easy monetary policy has, in fact, ensured that the global economy continues to display such comatose behaviour, excessive dosage of medicines notwithstanding.
No financial crisis ever takes place without borrowing and, in general, excessive borrowing. That was also true about the last crisis. The policy should therefore, have concentrated on reduction in global debt. Instead, the low interest rates and easy availability of credit encouraged borrowing on an unprecedented scale over the past few years, leading to debt levels that are higher today than at the time of the crisis. The conditions are therefore ripe for another major crisis. Our memory is still fresh with the default possibilities of many countries including Portugal Ireland, Greece and Spain, (commonly and quite appropriately referred to as the PIGS countries), all of which had to be bailed out to prevent such an eventuality. How long can the global financial institutions and community continue to bail out countries, under risk of imminent default and whether such accommodation would also be extended to emerging markets, is an interesting point to ponder.
In any case, prolonged use of easy money is making monetary policy highly ineffective. When the next crisis strikes and it will strike sooner than we think, and in a segment of the economy we may not have envisaged, there will be no ammunition left in the armoury of the Central Bankers to avert the crisis. What that does to the global financial architecture and the global economy is too scary a thought to even contemplate. But, finding the culprit for such an eventuality will not be difficult. Unfortunately, by then it will be too late.
, a financial consultant and teacher, has over three decades experience in the corporate sector, consultancy and academics.)