Avoiding a slowdown

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By admin March 18, 2019 17:39

The issue

In a seemingly coordinated effort, the Central Banks of almost all major economiesof the world (including India) have begun to apply brakes on increase in the interest rates. This has been in response to signs of global economic slowdown. Here, we will analyse the background to the issue, the various ways the interest rates  are being eased and the possible effects and aftermaths in short and long run of such a policy.

 

Background

Once the signs of ebbing of recession began to show and growth started picking up, these developed countries started normalising the monetary policy by beginning to follow a hawkish stance on monetary policy whereby interest rates were gradually raised.

 

What is the hawkish stance of monetary policy?

Under this stance, the interest rates are increased. This makes the credit dearer and consequently brings about a reduction in the money circulation. It has the following effects :

• Due to reduction in money supply, the inflation is reduced.

• However , due to lesser money circulation, it can even lead to reduction in GDP growth.

• Sometimes, currencies may appreciate in developing countries as rising interest rates may lead to higher capital inflow to earn more interest and the demand for domestic currency can increase.

 

Background

Quite obviously, the dovish stance has effects opposite to that of hawkish stance :

• Due to increase in money supply, the inflation generally increases.

• The increase in money supply also leads to increase in GDP growth.

• Sometimes, currencies may depreciate in developing countries.

 

So, what happened now ?

The global economy is showing signs of slowdown in terms of both slowdown in GDP growth and lesser job creation. Accordingly, the central banks of major economies seem to be putting a halt on their hawkish monetary policy stance in order to avoid a global recession : •

US Federal Bank has announced that it does not intend to hike interest rates further.

• European Central Bank has decided to maintain lower rates of interest for at least 1 more year.

• People’s Bank of China has similarly promised various monetary stimulus measures. •

Even RBI has reduced repo rate ( benchmark policy rate )

 

Need for a fine balance

Such coordinated efforts by central banks will definitely help prevent slowdown . However, sustained lower interest rates can have certain adverse effects :

• The borrowings will rise leading to higher debt ridden economies.

• The increase in money supply can lead to rise in inflation.

• This can lead to destructive bubbles in disguise of economic growth. So, central banks will have to keep a close watch on the trends and data that emerge from this coordinated step of reigning in interest rates and reverse this trend once signs for global economy stop looking bleak. They have to basically watch out for the danger of extended periods of low interest rates which have a tendency to lead to destructive bubbles

admin
By admin March 18, 2019 17:39