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.
Excerpt from the Antonio Fatas and Ilian Mihov blog on the global economy
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.”