Photo: Mint
Photo: Mint

Opinion | The message from the monetary policy week

What the Reserve Bank of India (RBI) dida potential pre-emptive tighteninghas to be given more credit than it has received

A week of central bank action is over. India raised the policy rate by 25 basis points for the second time this year and the repo rate is now 6.5%.

The Federal Reserve did not raise interest rates but sounded confident enough that analysts are now expecting a rate hike in the next meeting in September.

The Bank of Japan was the first one to meet in the week ended. It made some tweaks to the monetary policy but nothing dramatic. We will deal with that in a bit.

The Bank of England (BoE) raised the interest rate on Thursday. Its policy rate now stands at 0.75% and the Financial Times screamed on Friday that it is at the highest level in nine years! Yeah, right. Not satisfied, it wrote an editorial berating the BoE for being “irresponsible" with a rate hike at the wrong time.

In 2012, the BoE published a paper on the impact of asset purchases (The Distributional Effect Of Asset Purchases, July 2012).

It acknowledged that BoE asset purchases, post-2008, had disproportionately favoured the wealthy. Between 2009 and 2012, the BoE bought £325 billion worth of assets translating into a wealth effect of £600 billion, based on financial market reaction (higher prices of corporate bonds, gilts and stocks).

These wealth effects accrue, naturally, only to those who hold financial assets. The paper noted, based on a survey cited, that close to 80% of the financial assets were held by those above the age of 45 and that the median household only had an average of £1,500 of gross assets.

Further, the top 5% of the households held an average of £175,000 of gross assets, or around 40% of the financial assets of the household sector as a whole.

In April 2018, the Office for National Statistics in the UK released the annual nationwide housing affordability statistics (goo.gl/4j2FUq). Three observations from the report stand out:

• The affordability ratio has more than doubled for every property type in England from 1997 to 2017.

• 69 local authorities in England and Wales had significant differences in the ratio of median house prices to median workplace-based annual earnings over five years, between 2012 and 2017.

• All but five London boroughs saw significant worsening of affordability since 2012.

BoE monetary policy had made homeowners richer and put homes out of reach of prospective buyers, especially the lower income and younger population. Yet, the Financial Times berates the BoE for making a token adjustment to the interest rate after nine years to 0.75% when the inflation rate is at around 2.3%. Real rates are still substantially negative.

In 2016, the BoE pre-emptively cut interest rates after the Brexit vote. However, neither the economy nor asset prices suffered a meltdown in the country. It merely stoked the bubble in real estate prices further. What the BoE did last week was to remove the needless insurance cover it had provided the economy two years ago—a policy that has made asset-owners and capitalists rich. Yet, such a move has come in for criticism.

A different problem is playing out in Japan. The pledge by the Bank of Japan (BoJ) to target the yield on the 10-year government bond at 0.0% has made lending an unprofitable proposition for banks. Net interest margins have shrunk for many small and regional banks. So, many expected the BoJ to raise the yield on the 10-year government bond that it is targeting. It did not do so but conceded that it would tolerate a higher fluctuation in the bond yield. Thus, officially, the policy remained unchanged. Despite all these years of powerful and persistent qualitative and quantitative easing in Japan, the inflation target of 2% remains as elusive as ever. BoJ confessed: “Prices have continued to show relatively weak developments compared to the economic and employment conditions…and it is likely to take more time than expected to achieve the price stability target of 2%."

It is even possible to question if the appropriate price stability target for a population with negative demographic impulses and potential growth of 0.0% is something lower than 2%.

In sum, the message from the week of activity by central banks in the spotlight is that it is far easier for central bankers to cut policy rates than to raise them.

Public discourse will not let them do it until it is too late—that is, until many signs of overheating stare them in the face. By then, it will be impossible to stop the inevitable economic recession and asset price correction. Monetary policy tightening will be blamed for precipitating them. The loose monetary policy that precipitated the overheating will not be blamed. To compensate, central banks will now ease aggressively again! The race to the bottom for interest rates and for intelligent policymaking will continue.

This is modern monetary policy in a nutshell. Against the backdrop of this model, what the Reserve Bank of India (RBI) did—a potential pre-emptive tightening—has to be given more credit than it has received.

Finally, let us praise the Bank of Brazil for the lucid English translation of its brief and clear monetary policy statement after its meeting on 2 August. RBI may do well to reflect on its brevity, simplicity and clarity.

V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk

Comments are welcome at baretalk@livemint.com

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