Fault Lines 2.0 – Is The World Already Moving Towards A Depression?
The governor of the Reserve Bank of India, Raghuram Rajan, who was one of the few economists to warn of the 2008 global financial crisis before it hit, recently sounded the alarm bell again. In a conference at London in June this year Rajan cautioned that nations in a bid to revive growth are working at cross purposes. Central banks around the world are adopting the kind of beggar-thy-neighbour strategies that were followed in the 1930s leading to the Great Depression.
This is direct reference to the excessive monetary easing policies that have been followed by the central banks of the developed economies in the aftermath of the financial crisis. Whereas during the Great Depression countries wrongly adopted competitive devaluation of their currencies to spur economic recovery, today monetary easing seems to be the favoured policy.
There have been massive quantitative easing policies launched by the Federal Reserve of the United States, Bank of England, The Bank of Japan amongst others to pump in more money into their economies. Consider this; the Federal Reserve has not raised interest rates for the past 10 years since 2006. While the Bank of England’s base rate today is 0.5%, before 2009, it had never fallen below 2%. And that is still healthy compared to the euro area and Japan, where rates in 2018 are expected to remain stuck near zero.
The idea behind this monetary easing and lowering interest rates is to achieve inflation targets so that people spend more money and in the process boost economic growth. Other than trying to get consumption going again, there is another side to this story, too. When countries print more money, they also want to cheapen their currency against other currencies and, thus, boost exports and discourage foreign imports. But this has made things difficult for export oriented economies like China, where consumer demand has not been the major driver of growth. To protect their competitiveness, countries are intervening in markets like China’s recent devaluation of the Yuan to boost exports and check its economic slowdown.
However such protectionist policies by nations could lead to compression in global trade and overall demand for products similar to what happened during the 1930s. And this can lead to more problems than solving the current ones. This is put very well in Rajan’s own words: “The question is are we now moving into the territory in trying to produce growth out of nowhere or we are in fact shifting growth from each other, rather than creating growth.”
This lack of coordination between central banks across the world is producing spillovers that may get difficult to control and could force the world into another crisis, at a time when the world is less than capable to handle it. Developed countries’ average debt-to-GDP ratio has risen by more than 50% in last decade. Overall, global debt now sits right at $200 trillion — nearly three times larger than the world’s entire economic output in a given year. Monetary policy easing has led to near zero interest rates which mean if central banks face their next recession, they risk having almost no room to boost their economies by cutting interest rates further. Rarely have so many large economies been so ill-equipped to manage a recession.
This calls for all the more measures at a global level to check any impending recession. The central banks of the world need to work in a much more coordinated way so as to avert any major financial crisis. As Rajan had earlier suggested this may require multilateral institutions like IMF to take up the role of an international regulator to re-examine the ‘rules of the game’ – for responsible policy making, and develop a consensus around new ones. It needs to be ensured that no matter what a central bank’s domestic mandate; international responsibilities should not be ignored.
This article was prepared by Currenc-I, the Economics club of IIM Indore.