Are “unconventional” monetary policies (UMPs) deployed by the advanced economies a cure worse than the disease? Your columnist has asked this question on numerous occasions in recent years, as it becomes increasingly evident that the harmful side effects of UMPs, which helped alleviate the worst symptoms of the global financial crisis, are increasingly distorting not only the financial sector but the real economy as well, and causing serious and harmful “spillover” effects on emerging economies such as India.
Raghuram Rajan, former governor of the Reserve Bank of India, has been a well-known critic of UMPs, and, in particular, the damaging effects of the “taper tantrum” of 2013, in which then Federal Reserve Board chair, Ben Bernanke, had to walk back from plans to taper the large scale asset purchases — commonly called “quantitative easing” — after his remarks that they would begin to taper, touched off a firestorm in international financial markets, and hit emerging economies, including India, especially hard.
Recently, Rajan penned a column (“The Dangers of Endless Quantitative Easing”, Project Syndicate, 2 August), in which he weighed in on the current debate occurring amongst members of the Fed as well as academic and bank and corporate economists on whether it is now high time for the Fed to taper its asset purchases, at present $120 billion per month. Rajan’s view is that supply constraints are now more pertinent than insufficient demand, and excessively accommodative monetary policy runs the risk of stoking inflation, which would have fiscal implications in the medium to longer rum, increasing the servicing costs on the large stock of government debt due to interest rates that will eventually have to go up as inflation begins to spike.
On 18 August, speaking to the Financial Times (“Top Fed official warns massive bond purchases are ill-suited for US economy”), Eric Rosengren, president of the Boston Fed, threw his weight behind the Fed board beginning to taper after it meets next month, with the aim of winding down asset purchases altogether by the middle of next year, again citing supply constraints, such as the difficulty employers in the US are encountering finding workers, even as they offer higher wages. Importantly, Rosengren pointed to the harmful effects of asset price appreciation and “undue leverage”, as fund managers take on more and excessive risks in the search for yield in a low-interest environment.
Ironically, asset price bubbles fuelled by leverage and low interest rates were the proximate cause of the global financial crisis to begin with, and they are in play once again as a serious side effect of low interest rates and asset purchases used to combat the effects of the crisis. This is a little like someone suffering insomnia, who then gets hooked on sleeping pills, and is unable to taper them and ends up taking them for life. Unless the US, and other advanced economies, begin to take seriously the need to pull back from UMPs, this is the situation we may end up in.
It is worth reminding ourselves that debates about monetary policy are not merely an esoteric pastime for central bankers and finance gurus. Rather, excessively loose monetary policy has long-lasting and perverse effects on the real economy, too. One of the most damaging of these side effects is the increase in wealth and income inequality that has been abetted by low interest rates and asset price inflation.
It is, after all, the already wealthy who have money to invest, and skyrocketing asset prices, everything from property to antique automobiles, boosts their wealth and income. By contrast, lower income households put their money in the bank, where they earn low, almost zero, interest rates that barely keep pace with inflation.
There is more than a little bit of irony in the fact that loose monetary policy, which has received widespread support from left-leaning economists in the US, actually has done more to worsen inequality than the effects, say, of former President Donald Trump’s tax cuts, which were widely criticized for being pro-rich. A recent study, reported on by Bloomberg (“U.S. Wealth Gap Rises With Jackson Hole Coming at the Top”, 18 August), documents widening wealth gaps between the top and bottom deciles of US counties. Looking at income from assets, in particular, interest, dividends, and rents, on a per capita basis, the top 10 percent of counties earned about $20,000 in asset income per person, on average. Meanwhile, in the bottom 10% of counties, that figure was only about $7,500. This has very little to do with the structure of taxation and very much to do with the distorting effects of low interest rates and frothy asset prices.
There are also more conventional dangers that lurk, unless the Fed and other advanced economy central banks get serious about winding down asset purchases and returning policy interest rates to more normal territory and away from near zero. During the “great moderation”, a long period of low inflation that preceded the financial crisis, there was a smug insouciance amongst central bankers and even academic economists that high inflation was a thing of the past. But with inflation now starting to tick up in the US and elsewhere, that smugness may soon evaporate, as Fed officials realize that it is far from easy to put the inflation genie back in the bottle, once it has been uncorked.