Mario Draghi, the president of the European Central Bank, speaks during a hearing by the European Parliament Committee on Economic and Monetary Affairs at the European Parliament in Brussels, Belgium, on July 9, 2018. Photo: EPA-EFE
Nicholas Spiro
Nicholas Spiro

Four reasons quantitative easing is not the solution to the global economy’s problems right now

  • The damaging effects of the previous rounds of quantitative easing are still being felt in low bond yields, falls in European and US bank shares and increased income inequality
  • Further monetary policy loosening might convince investors a recession is imminent while a market rally could encourage Trump in his trade war

One of the reasons why financial markets had such an abysmal 2018 was the fear among investors that quantitative easing – the extra cash pumped into the financial system by the world’s leading central banks to cope with the fallout from the global financial crisis – was giving way to quantitative tightening.

According to data from Bloomberg, the collective balance sheet of the US Federal Reserve, the European Central Bank (ECB) and the Bank of Japan peaked in March last year and began shrinking in October. As recently as last December, investors were fretting about an excessive tightening in US monetary policy as the Fed – which raised interest rates four times in 2018 – downplayed the dramatic sell-off in stocks and signalled two further interest rate hikes this year.
These worries are now a distant memory. The Fed’s abrupt decision last January to shelve its rate increases because of mounting threats to the global economy sparked a dovish shift in global monetary policy that has gathered steam since US President Donald Trump revived his trade offensive against China last month.
Fed policymakers are dropping heavy hints that rates will be cut if trade tensions intensify – bond markets now anticipate at least two reductions by the end of this year – while the ECB is considering relaunching its quantitative easing programme, which it halted last December.
The BOJ, which is still pursuing quantitative easing, has just pledged additional easing measures if inflation falls further below its 2 per cent target. Meanwhile, Australia’s central bank cut rates last week for the first time in three years, partly because of China’s economic slowdown, while several emerging market economies, including Malaysia and the Philippines, have reduced borrowing costs in the past month.
Bank of Japan governor Haruhiko Kuroda arrives at the central bank’s headquarters in Tokyo on April 25 for the second day of a two-day policy meeting. The bank later pledged to keep interest rates “extremely low”, at least until the spring of 2020 in a bid to underpin the economy. Photo: Kyodo

To be sure, the outbreak of dovishness is not without foundation. In the euro zone, a closely watched market measure of inflation has fallen to below 1.2 per cent, down from 1.7 per cent for much of last year, fuelling concerns that inflation expectations are becoming “deanchored”.

Even in the US, whose economy is still relatively buoyant, growth is weakening. A gauge of manufacturing activity fell to its lowest level last month since October 2016, while employment gains slowed sharply, heaping pressure on the Fed to deliver an “insurance” rate cut to sustain America’s economic expansion.

Yet while the threat of a protracted US-China trade war is exacerbating the global economic slowdown, the case for a dramatic loosening in monetary policy is a tenuous one, to say the least. A calibrated easing is one thing; another round of quantitative easing is quite another.

First, the damaging side-effects of previous rounds of quantitative easing have not gone away. The most conspicuous one is the distortions in markets. Years of super-loose monetary policy have caused bond yields to drop to excessively low levels, regardless of the creditworthiness of companies and countries.

Investors are no longer differentiating sufficiently between good and bad borrowers. The further yields fall – the benchmark 10-year US Treasury yield has already fallen nearly 50 basis points since mid-April – the more distorted asset prices become.

The Fed’s quantitative easing report card is mixed – except for the rich

Second, ultra-low rates – which are below zero in the case of Japan and the euro zone – have eroded the profitability of banks whose net interest margins have shrunk significantly, particularly in Europe. The prospect of looser monetary policy has led to sharp falls in European and American bank shares over the past month.

More worryingly, quantitative easing has exacerbated social divides. The wealthy have benefited from higher asset prices while those with no financial assets have seen the returns on their savings shrivel. The reality is that quantitative easing has contributed to rising populism in Europe and America.
A demonstrator sporting a mask representing French President Emmanuel Macron holds a yellow flower during “yellow vest” protests in Rouen on April 6 2019. France has been rocked by months of weekly Saturday protests by the yellow vests, which emerged over fuel taxes before snowballing into a broad revolt against the French president. Photo: AFP
Third, another burst of quantitative easing – and looser monetary policy in general – could easily backfire if investors perceive such action as a sign that central banks are worried about an impending recession.

The last thing the global economy needs right now is increasing market anxiety about a sharper downturn in the US, the one major economy which, for the time being, is still performing relatively well. Investors should be careful what they wish for, while the Fed needs to be ultra-careful not to miscommunicate its policies.

Finally, even if further monetary easing does trigger a rally in markets, this could encourage Trump – who continues to berate the Fed for having raised rates – to prolong the trade war. As I argued previously, markets have an important role to play in putting pressure on both sides to de-escalate the conflict. Additional stimulus could prove counterproductive.

When the Fed holds its rate-setting meeting next week, it will be acutely aware of the risks involved in turning on the monetary spigot once again. With some investors expecting as many as four rate cuts this year, the Fed has a duty to explain to markets why looser policy could end up doing more harm than good.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: World doesn’t need another dose of quantitative easing