BackQuestions for Ben Bernanke
The key assumptions behind quantitative easing are that there is demand deficiency and monetary policy can address it
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After this newspaper published my analysis of the speech by Reserve Bank of India governor Raghuram Rajan at the Brookings Institution on Thursday, I watched the video of the event. Ben Bernanke, former chairman of the US Federal Reserve, was in the audience and he posed the first question to Rajan. He said that because of the sterilization of foreign exchange intervention by emerging economies, their exchange rate interventions amounted to diversion of demand (from the developed world to the developing world) whereas quantitative easing (QE) was not money-neutral and hence amounted to augmentation of demand. Interestingly, in his 1999 mimeo, Japanese monetary policy: a case of self-induced paralysis, Bernanke advocated aggressive yen depreciation and said exchange rate depreciation was both augmenting (it raised home country income) and trade diverting. Rajan responded that the effectiveness of such demand-augmentation effect of QE was muted by the stock of debt that had to be dealt with first before accommodative monetary policy became effective.
Bernanke’s arguments are nothing new. In his 1999 paper, he laid out a series of steps that he thought that Japan should pursue to address its aggregate demand deficiency. Japan tried them in the new millennium all as Masaaki Shirakawa, former governor of the Bank of Japan, pointed out in a presentation in 2012, without anything to show for their efforts. Now, a recent International Monetary Fund Working Paper (Shock from Greying: Is the Demographic Shift Weakening Monetary Policy Effectiveness?) concedes that ageing populations undermine monetary policy effectiveness and, hence, as a remedy, suggests bigger monetary policy moves to achieve the same effect. There is no consideration of the possibility that this medicine is ill-suited for an ageing society, regardless of the dosage.
There are several underlying assumptions behind both the diagnosis of demand deficiency and the QE prescription. The key ones are that there is indeed a demand deficiency and that monetary policy or money can address it. An ancillary assumption is that the high stock of pre-existing debt will not undermine the effectiveness of low interest rates in stimulating consumption and investment.
Yours truly too has noted on several occasions that the growth spurt that followed the end of World War II had to do with the rebuilding that was required after the destruction of the war and the Great Depression that preceded it. Once those deficiencies were plugged, economic growth stagnated and further attempts to stimulate growth in the 1970s produced stagflation. Then, from the 1980s onwards, a combination of debt, financialization and globalization helped propel growth with more frequent asset price booms and busts becoming a permanent feature of the economic landscape.
What the global economic crisis of 2008 signalled to policymakers was that they had pushed the envelope too far on debt-induced growth and they needed to accept that there is no deficient demand but that there were supply constraints (hydrocarbon, water and environment, to name few) that were becoming more binding on the economy. Therefore, there may not be demand deficiency but a permanently lower potential growth. Attempts to deal with this as a cyclical demand deficiency will not only fail to lift economic growth rates but also entail huge financial stability costs. Signs of costs to financial stability are pervasive—record number of stock offerings, companies with no profit commanding huge valuation in the stock market, record-low risk premium on all kinds of speculative grade debt (sovereign and corporate), record levels of margin debt in US stock markets and low lender protection in speculative grade bonds, etc.
As to whether QE has lifted the growth rate, the American labour market presents some sobering evidence. Five years after the interest rate was dropped to zero and after three rounds of QE, job creation in the US is confined mainly to low-paying sectors. In the 12 months to March, the US created around 2.24 million jobs. Jobs created in the services sectors were 2.04 million. Of these, 1.48 million jobs were created in retail trade (315,200), administrative and waste management services (423,600), education and health (334,000) and leisure and hospitality (406,000). Under leisure and hospitality, food services accounted for 323,000 jobs.
Despite claims of a much vaunted revival of US manufacturing, only 72,000 jobs were created in the sector in the last 12 months whereas 151,000 construction jobs have been created. No surprises then that, in the last 12 months, participation rate and the employment to population ratios for those who have completed high school or less have gone up whereas these two ratios have declined for those with a college or associate degree and a bachelor’s degree or more.
Since Bernanke will be in Mumbai on Tuesday, we may want to ask him a few questions, especially since Rajan won’t be around in Mumbai to take Bernanke to task.
V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com.
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk
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