Exit from monetary stimulus

Globally, financial markets remain unsettled and currencies are volatile as 2003 runs out, mainly due to anticipation of a decision by US Federal Reserve by end December to begin a gradual tapering of its unconventional monetary policy (UMP) or ‘quantitative easing’, while keeping intact its key policy rate at near zero for an extended period.

There is a growing debate among economists and senior Fed officials on merits and demerits of sustained asset purchases but evidence points to a more likely start in unwinding in the early months of 2014. Fed began the programme of purchases of us treasury and other assets in September 2012 totalling 85 billion dollars a month to hold down long-term interest rates and foster post-recession growth recovery and employment.

With a tight fiscal regime to hold down deficits and debt, mandated by Congress, the Federal Reserve’s monetary policy has helped to stabilise the financial system, strengthen economic recovery and generate jobs, even as it has raised its balance-sheet by 3.8 trillion dollars over five years. It is the unexpected spurt in US GDP growth to 2.8 per cent in the third quarter (July-September) coupled with an equally encouraging job addition in October of 2,04,000 to the pay roll that triggered renewed market worries over an early tapering of UMP. But the growth and job numbers have their own underlying weaknesses.  The growth bounce has to do more with inventory-building and some support from the reviving housing market while lacking consumer confidence. The job additions are mostly at lower-levels and the unemployment rate is still high at 7.3 per cent of the labour force, and thus the labour market and the economy are performing far below their potential.

Fed’s mandate is to promote full employment and price stability with an inflation target of two per cent. Inflation in USA has also been low below the Fed benchmark thus requiring monetary policy support to bring about a robust growth of economy, according to Fed officials.  However, US economic recovery can become sustainable only with the return of consumer confidence as retail sales make up two-thirds of the 16.5 trillion dollar economy. But more worrisome are trends on the other side of the Atlantic, the crisis-ridden Euro-zone in recession for a second year, now in the grip of deflationary fears. The fall in consumer prices to as low as 0.7 per cent in October forced the European Central Bank (ECB), on 7 November to cut down the interest rate to a record 0.25 per cent.  The ECB President Mario Draghi is on record to do ‘whatever it takes to preserve the euro-zone’.

ECB does not see any catastrophic situation and rules out a Japan-style deflation in prospect nor does it consider possibility of quantitative easing (as in USA or Japan). It is simply unthinkable with Germany wedded to austerity at the centre of policy-making in the zone. While the interest rates are now brought down near zero, as in USA, Draghi says the bank has room for further action if warranted by circumstances.

Globally inflation is falling, though it is not the case in several emerging economies, let alone India’s uniqueness for the highest rate of CPI, (also a pre-election dread for India’s UPA government with its benign neglect of inflation). Monetary authorities in both Europe and America are faced with fighting deflationary forces. Consumer prices across developed regions as a whole in October were at 1.5 per cent, driven lower by food and energy prices. The overall outlook for US economy is one of faster recovery than in Euro-zone with its myriad problems in growth, safeguarding the far-from-unified 17-country union and the value of euro, its common currency. Its endemic unemployment in conditions of fiscal austerity, dictated by the zone’s strongest economy Germany, has remained high at 12.2 per cent, still higher in peripheral countries peaking at 27 per cent in Spain.

Even with growth at around two per cent in 2013, the US economy will make a stronger entry into 2014 with a projected rise to 2.6 per cent than the Euro area, which could emerge from recession to one per cent growth. The continuing policy challenges for fiscal adjustments, reduction of global imbalances, financial stability and rebalancing of growth in emerging economies like China and India will make 2014 another year of slog for the world economy. China’s trade expansion has proceeded apace in the first 10 months with a surplus of $200.4 billion, according to Customs data. But acknowledging that it could no longer continue to grow on the basis of high investment and exports, China is now embarking on what it calls a ‘comprehensive deepening of reform’ as approved on 12 November by the Third 

Plenum of the Central Committee of the Communist Party.

A Communique sets out the directions of reform but details would have to emerge for an assessment of the new model that China is seeking to create for global pre-eminence. The goals include a ‘decisive role’ for the market in allocating resources, establishing a modern fiscal system, relaxation of investment rules, land reforms, a new urban-rural pattern and building a ‘law-based and service-oriented’ government.    IPA