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Home >Opinion >Views >The world must call out America's easy money policy

The General Agreement on Tariffs and Trade (GATT) was signed by 23 countries in October 1947 with the objective of minimizing trade barriers by eliminating or reducing quotas, tariffs and subsidies, while preserving significant regulations. In 1995, the GATT was absorbed into the World Trade Organization (WTO), which extended the agreement. By this time, 125 nations were signatories of its agreements, covering about 90% of global trade. In brief, the WTO claims to ensure free trade among its members by ensuring that no one subsidizes its exporters or restricts imports using tariffs/quotas or any other discriminatory policy.

The rationale of WTO membership is multi-fold. All parties get to trade freely with one another and sanctions can be used against the non-compliant members. Further, the law of comparative advantage says free trade is highly efficient and beneficial for all involved. Since discriminatory trade policies by one member affect all others, and create negative externalities, they’re unacceptable. We saw this in October 2019, when the WTO recommended that India withdraw “prohibited subsidies" under the Merchandise Exports from India Scheme within 120 days. India replaced that scheme with one for remission of duties and taxes on export products.

Global cooperation goes beyond world trade to other international institutions, such as the International Monetary Fund (IMF), World Health Organization (WHO) and the Bank for International Settlements (BIS), which prepare globally acceptable norms and rules for countries to adopt. Notably, though, the huge overuse of monetary/fiscal easing has never been considered a contentious issue in global economics. Notwithstanding the large negative externalities of over-stimulus by the US for the rest of the world, there is no discussion on how to bring it under the umbrella of global cooperation. One reason may be that the practice is common to almost all nations. However, an economic stimulus per se is not a problem; its excessive use is, especially by the world’s largest economy.

When the US Federal Reserve opts to (1) buy corporate bonds (including junk bonds), thus supporting the froth in risky financial markets, and (2) finance the US fiscal deficit, by which unconditional money is given to a large part of its population, this does have serious implications for the rest of the world. Although the injection of US dollar liquidity is essential to arrest the collapse of the global financial system, excess stimuli is a cause for concern, especially emerging and developing economies (E&DEs).

When the US Fed eases monetary policy and injects dollar liquidity, a flood of foreign capital enters E&DEs. Since the central banks of most E&DEs intervene in currency markets, higher capital inflows restrict their ability to support their domestic sovereign bond markets. This forced choice of managing either the currency or bond markets can pose policy complications.

Similarly, when the Fed decides to scale back its monetary stimulus, E&DEs brace themselves for capital outflows and related volatility, as seen during the 2013 ‘taper tantrum’. Further, although still open to debate, if the US sees high inflation next year and the Fed moves to fight inflationary pressures, this could lead to a global crisis. As foreign capital flows out of E&DEs, their currencies would weaken and domestic financial markets would turn highly volatile. While the Fed would still know what to do, the central banks of E&DEs would be crushed between (1) the need to reduce interest rates to support the domestic economy/financial markets and (2) the pressure to keep interest rates high to attract more foreign capital flows and fight inflationary fears from a weakening currency. No matter what E&DEs do, their authorities tend to lose control of their economies and financial markets because of skewed US monetary policies.

What’s worse is that as US policymakers go in for huge stimuli in support of US consumers and producers, significant pressure mounts on the governments of E&DEs to replicate American policies. If the world’s largest economy can support private businesses and distribute free money to citizens, people elsewhere ask, why can’t our government do the same? Such an approach and its ideological basis may seem imprudent to domestic policymakers, but it would be an extremely difficult task to explain the nuances of the argument against it to the general public. Dissatisfaction among people, especially those who make superficial comparisons with rich countries, however, may result in political instability.

Don’t these indirect consequences of unprecedented economic stimuli by US authorities, thus, amount to negative externalities? By crediting free money into citizens’ bank accounts and creating a positive wealth effect for local producers, don’t these policies count as discriminatory? How are these policies different from another government subsidizing its exporters or restricting imports through tariffs? If the latter is unfair, then should the former be allowed?

The primary objective of all international institutions is to ensure a level playing field for all nations, for which uniform and strict ground rules are set. As the US is the world’s largest economy and sole issuer of the global currency, its economic policies have widespread implications for the rest of the world. It is only sensible, then, for the US to be more responsible in setting its policies. In case it fails to behave responsibly, it becomes the responsibility of other countries and various international institutions to get the US to act in a manner that’s globally acceptable.

Nikhil Gupta is an economist at Motilal Oswal Financial Services Ltd.

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