When central bankers across advanced economies went guns blazing on accommodation in the aftermath of the global financial crisis, little did they know that ultra-loose monetary policy will attack the very objective of raising inflation.
Now their worst critic is a former central banker of an emerging market economy -- India. Viral Acharya, former deputy governor of Reserve Bank of India (RBI), in a speech on 20 October, said ultra-loose monetary policy puts its very objective of raising inflation at risk by depressing inflation especially when financial lenders lack capital.
Through Europe’s example, Acharya explained how ultra-loose monetary policy at some point begins to depress inflation. “Accommodative monetary policy in the presence of a weak financial sector creates zombies and disinflation, working precisely against its mandated objective of raising inflation when it is below the target levels," said Acharya.
When central banks create a liquidity glut, the incentive for banks is to push credit. But without capital heft, lenders tend to fall prey to ever greening of loans where they lend to non-viable companies just to keep default rates low. Acharya called this the zombie credit cycle. Such a credit cycle creates zombie firms and excess capacity that eventually depresses inflation, Acharya said citing his research paper.
Indeed, criticism for ultra-loose monetary policy has increased across the globe since a record amount of sovereign debt is offering negative yields. Former European Central Bank ECB chief Mario Draghi had admitted that his “whatever it takes" approach hasn’t yielded the desired effects on inflation in the euro area. Acharya compared the absence of a rise in inflation in Europe to Japan’s similar struggle which resulted in the country dealing with a depressed inflation for decades.
“The glut of cheap credit and liquidity following the ECB’s ultra-accommodative monetary policy appears to have thus prevented a creative destruction or normal competitive dynamics in which impaired unproductive firms are driven out of the market or at least significantly lose their market share to existing healthy firms and efficient new entrants," Acharya said.
Is there a message for India in this?
Acharya hasn’t mentioned India in his speech but there are some lessons for the country.
Despite record recapitalisation, India’s banks still lack the capital muscle to go out and lend. The RBI is in an accommodative mode and is willing to keep liquidity in surplus to facilitate credit flow. That said, the current slowdown in the economy complicates lending for banks. The central bank should closely monitor credit flow and the government should be cautious in pushing loan melas. Pushing credit assessment standards lower to accommodate a larger borrowing populace would spell eventual disaster as non-viable companies would get cheap credit.