Even as the monsoon advances, another type of liquidity is set to recede this month. To what extent should we be worried?
US Federal Reserve chairman Ben Bernanke’s big gamble is scheduled to draw to a close by the end of June: Quantitative Easing 2 (QE2), or the second round of large-scale asset purchases by the US central bank. Bernanke had first hinted at a new bout of monetary easing a year ago, some months after QE1 had been wound down after a fairly successful run. QE1 had helped save the global economy from utter collapse. But there were mounting fears about a double-dip recession in the West towards the end of 2010. Bernanke decided to move ahead with QE2, a massive $600 billion bond-buying programme. After all, financial markets had been weak through the summer. Stock and bond prices had tumbled after QE1 ended.
Will we see a repeat of this in the coming weeks? The possibility cannot be denied. There is no shortage of pessimists who predict the end of QE2 will result in carnage in the equity market, climbing US interest rates and a new round of economic instability. But, for now, the financial markets seem more concerned about the fiscal woes of Greece and the dangers of a hard landing in China.
There is no doubt that QE2 did inflate asset prices, especially commodities. The monetary easing in the US did add to inflationary pressures across the world. But we must also remember that many other predictions about the impact of QE2 were off the mark. It was hard to find an Indian equity analyst or mutual fund manager at the end of 2010 who did not forecast that QE2 would unleash a torrent of money into India and other emerging markets, sending share prices sky-high and creating exchange rate management problems for the Reserve Bank of India. Nothing of the sort happened. Capital inflows have not been overpowering and equity prices have stayed flat.
The withdrawal of QE2 is overdue. It should hopefully push down commodity prices in the short-term and ease inflationary pressures. But the effect of financial markets is unlikely to be catastrophic.
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