In a
recent report, the BIS have claimed that the recovery that is being made by the
European economy needs to be dampened so as not to re-enter a grossly
over-inflationary period of growth. A journalist for The Economist magazine
going by ‘R.A.’ reported: ‘Though the BIS's diagnoses of the
global economy's ills have evolved over time its policy recommendations have
not. In its latest annual report, it argues that what the world needs now is
higher interest rates.’[i]
The BIS has fears that although the economies of the Europe have and will
benefit from lower bank rates as it allows them greater domestic potential for
consumption and investment, it is important to not just keep inflation low,
now, but to keep it manageable in the future. R.A. did not take kindly to this
and deftly countered by first picking some misconceptions that may have arisen
from the reports, and then - seemingly unknowingly- discussing some of The
International Monetary Fund’s (IMF’s)
Managing Director Christine Lagarde’s fears from January this year.
Firstly R.A. set about drawing a clear distinction between ‘loose’ and ‘tight’
monetary policy. Loose refers to when central banks expand the money supply and
increase the flow of money in the economy through increasing demand- this can
be either ‘aggressive’ or ‘passive’. From this, R.A. concludes that European
Monetary policy is as yet to be classed as truly loose as there has been no
QE/OMO thus far; ‘It's not the loosest possible policy if there are plenty more
arrows in the quiver.’1 He asserts that before the policy for Europe
tightens it must be loosened to allow for restructuring. Despite seemingly
being opposed to the BIS and their suggestions, the two perspectives seem to
have found a point of synthesis- the financial sector and economy alike needs
restructuring. The difference lies in how they both suggest this should occur:
where the BIS suggests that a contraction would force firms to adapt to the
additional pressures of higher interest, making them more prudent. On the other
hand, R.A. argues that ‘intense private-sector competition… and more inflation’
is still needed to avoid a return to abnormal economic conditions. Both of
these suggestions seem plausible, with the European Central Bank (ECB)
suggesting stress-tests[ii]
for large commercial banks, but also encouraging loose monetary policy.
In another article, in The Financial Times, Chris
Giles[iii]
wrote of the OECD and their bid to get the European Central Bank (ECB) to slash
base rates, and also broaden trade to allow for greater structural reforms ‘to
boost productivity and create jobs through… domestic and international
competition in both advanced and emerging economies.’ This position strongly
supports that of R.A. from the abovementioned piece. Giles’ brings a more
quantitative perspective to this issue, quoting the OECD’s findings on how the
real GDP growth of the Eurozone is improving, but not completely out of the
reach of negative figures (see Fig. 1). In addition to validating the
stipulation made by R.A. Giles is able to expand the on argument by referring
to the possible loss of economic capacity in the medium-to-long-term. There are
a number of possible causes for this: long-term unemployment and a widespread
loss of transferrable skills; falls in foreign and domestic investment due to a
loss of confidence; and even an increase in inefficiency in investment due to a
lack of use of the mechanisms and infrastructure for such an extended period.
All of the above analysis from this range of
sources and from the macro-economic theory discussed points towards a middle
path between the two solutions suggested that errs slightly on the side of
loose monetary policy decisions. Had either perspective showed a greater depth
of analysis of the other, they would have been much stronger, providing a
deeper discussion. In spite of this, the strength of the arguments put forward
by R.A. and Giles are far more convincing those of the BIS especially
considering even some of the strongest recoveries that have been seen in
developed western countries still are somewhat fragile.
Kavi Chauhan-08/07/2014
[i]
R.A. (2014), Dead economies blow no
bubbles. The Economist, London.
[ii]
B. Moshinsky, J.Black, A. Speciale (2014), ECB
Haggles on Pain to Inflict in Bank Health Check, Bloomberg News, Brussels
and Frankfurt.
[iii]
C. Giles, (2014), OECD urges European
Central Banks to loosen monetary policy. The Financial Times, London.
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