Grading Carney and el-Erian

In a blog post for Financial Times, Mohamed el-Erian had written that the Bank of England deserved an A for their action and communication in the first week of August. This blog post will be kinder to El-Erian even though he has been too kind to Bank of England and its governor. Between the lines, El-Erian has hedged himself on the effectiveness and even appropriateness of the policies that Bank of England announced nearly two weeks ago.

This is what I would say on the Bank of England decision:

Just last week, the Bank of England brought out its monetary policy bazooka. It lowered interest rates; committed itself to lowering it further; resumed quantitative easing; extended it to corporate bonds and got sanction for another GBP100bn of QE to be kept in reserve, literally.  All this based on a GDP growth forecast that may or may not materialise. Even if it materialises, it may well be due to the eventual and inevitable bursting of the asset bubbles that policies such as this fuel. In other words, the policy meant to stave off a growth slowdown might very well be the cause of it, eventually.

The Bank of England (Willem Buiter noted recently that soon it may find its name truly reflect its domain) did not appear to have taken into account the fact that stock and bond markets have rallied since the Brexit vote in the UK in June. Had asset prices collapsed and stayed low, there would be some justification for the Bank to have acted to forestall an economic recession. That too is not the case. Hence, pushing interest rates down to zero or negative and unleashing quantitative response has become the unthinking pavlovian response of central banks to real or imagined economic slowdown or low inflation. On their part, financial markets with their pavlovian response to such policies, send asset prices to new highs. Both financial markets and central banks are defying logic and the former is defying gravity as well.

I had used the first of the above two paragraphs in my MINT column on the asymmetry of negative rates. Ultra-low negative rates can create deflationary expectations and they do but it does not mean that, to create inflation, central banks should raise interest rates! That logic is absurd as most things in economics are not symmetric. Relationships between economics variables are non-linear and asymmetric.

Coincidentally, FT, in a display of faux objectivity, had published an article by Prof. Amar Bhidé on the easy money policies of advanced nations. He wrote:

feeding another credit binge is a dangerous way to cure a debt hangover.

He is a Professor of International Business at the Fletcher School of Business at Tufts University. That led me to search for a sentence I thought I had used in one of my newspaper columns: “the idea that low interest rates are a cure to problems caused by low interest rates is risible”. I could not recall when I wrote that. In any event, I could not locate that comment.

Instead, in September 2007, in my column for MINT, I had written the following:

For problems and imbalances caused by low interest rates and excess leverage, the cure has been delivered: low interest rates.

Not able to find online link for this column titled, ‘Globalisation of financial blackmail’.


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