Monetary easing is finally working, but what happens when the cheap money goes away?
The global economy is finally heading back towards a growth path, according to the latest forecasts from the OECD. GDP in the U.S. is set to grow 2.8 percent next year, against 1.9 percent in 2013. Japan’s economy is forecast to grow 1.4 percent in 2014 after 1.6 percent in 2013 thanks to recent stimulus measures.
Even the crisis-stricken Eurozone can look forward to modest growth of 1.1 percent next year, after shrinking by a predicted 0.6 percent in 2013.
But the cautiously favourable predictions in the OECD’s latest Economic Outlook come with a health warning. These varying speeds of recovery have been achieved thanks to exceptional monetary easing in major economies, and new uncertainties lie ahead.
“There are new imbalances related to the huge amount of liquidity which has been poured into the system by central banks to support demand in the global economy,” says Piercarlo Padoan, Chief Economist and Deputy Secretary-General of the OECD.
The flood of easy money that is still needed to stave off recession carries with it the seeds of new potential trouble, Padoan warned in an interview with INSEAD Knowledge.
“This huge amount of liquidity is now looking for yield, and it is looking for assets everywhere. Even assets that in more normal times would be considered as too risky are being bought by investors. You see yields in what were once high-risk assets now being very low.”
By Antonio Fatas
, INSEAD Professor of Economics (Looking forward to the end of QE
, May 26) - The pattern that we see after each of the last recessions is that short-term rates deviate from long-term rates as a sign that monetary policy is hitting the accelerator (the yield curve becomes steep). A few years after the recession is over, short-term rates are raised and they reach a level similar to long-term rates.
We expect a similar pattern this time…and before that happens we will see a statement from the US Federal Reserve that QE is about to end (or to slow down at first). What is clear…is that it is taking longer than before for short-term rates to go back up to meet long-term rates, a sign that the current recovery is much weaker than previous recoveries.
What will we learn the day Ben Bernanke announces that we are starting that path towards normalization? It might be that we simply learn that he is becoming optimistic about growth in the US. This will be good news. It might not be a surprise to some who expected that type of growth going forward, but it could be a positive surprise to others that thought growth would never come back. In this scenario, it is difficult to think about such an announcement as bad news. We know that QE will end one day, we know that short-term rates will have to increase, so if the announcement was to be a surprise in the sense that it is coming too early, it would mean that there is a positive surprise in terms of growth happening earlier than expected -- and this has to be good news.
I see this scenario as more likely.
Problems could materialise when the time comes to pull back from monetary easing. “At some stage, monetary policy will have to slow its pace and eventually begin to think about exit. This is going to be a very delicate operation. We simply do not know how markets will react to a reversal of the monetary policy stance.”
Today’s uneven recovery, according to the OECD’s analysis, reflects uneven progress in two essential areas. Countries that have repaired their banking sectors, such as the U.S., are now well-placed to tap into the recovery, Padoan said. So are countries whose governments have succeeded in convincing investors that they have a medium-term plan for stable and sustainable growth.
But countries that have done less well in these areas are still vulnerable. That is particularly the case in Europe, where “most of the fiscally vulnerable economies will only exit from recession in the course of next year,” the OECD said in its latest Economic Outlook.
In the U.S., “after a sharp bounce-back in activity in the first months of 2013, GDP is now expanding at a moderate pace,” according to the OECD report.
Growth in the U.S. is being “held back by tax increases and the onset of poorly-targeted automatic budgetary sequestration. Nonetheless, improved financial conditions and very accommodative monetary policy should help GDP growth gradually gain momentum.”
“Private consumption growth, including car sales, will benefit from ongoing balance-sheet improvements and improving labour market conditions. Business investment growth should strengthen further, given healthy corporate balance sheets, strong profitability and low financing costs, and housing investment levels should continue to rebound as the housing market recovers.”
By contrast, “the Euro area economy remains very weak in aggregate, with increasing divergence between the prospects for member states,” the OECD observed.
“Activity is likely to continue to contract or stagnate until the second half of 2013, with continued fiscal consolidation, weak private sector balance sheets, low confidence, impaired credit supply in some countries and deteriorating labour market conditions being drags on activity.”
Overall, the OECD made clear the recovery remains fragile and still requires the support of central banks. Monetary policy needs to remain “extraordinarily easy” in the U.S., and easing was overdue in Japan. As for the Euro area, additional easing is needed to help Europe’s weaker economies.