© Marco Airaudo
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I agree with the view that looks at hyperinflation as a low probability event. If the main risk of quantitative easing (QE) was inflation, we would have probably seen some already, given the enormous increase in money printing occurred during 2008-2011. Since inflation has not picked up, it means that money injection has had some positive impact on real activity. In the case of the U.S., the unemployment rate has been brought down from 10% to below 8%. To me, this is a clear sign that QE had some success.
However, it is also clear that QE has considerably increased the size of central banks' balance sheets. Total assets held by the Fed and the ECB account now for about 25% of their respective GDPs, while they are around 10% in normal times. This is the result of the massive purchase of long-term government bonds, securities and MBS from banks and financial institutions facing liquidity shortages. The immediate benefits of this operation are clear: lower long-term yields, and making long-term loans more convenient to households and firms. The long-term costs are more uncertain. At some point in the future, central banks will probably unload these bonds, pushing up their yields. If in the meanwhile the global economy does not fully recover, we might face a new recession.
Central banks often seem to move in concerted fashion by easing monetary policy and cutting benchmark lending rates. Do you personally endorse the actions of central banks during the current period of global economic slowdown?
Global financial markets are so integrated that in order to reduce the risk of contagions and negative spill-overs, central banks – in particular the Fed and the ECB – have to act in a concerted fashion. This is not the consequence of any established agreement or explicit coordination, but simply the outcome of a strategic game played by two independent authorities. In most occasions, an interest rate cut by the Fed has in fact been closely followed by a similar manoeuvre by the ECB. The two largest economic areas in the world (the U.S. and the Euro Area) are subject to similar shocks, real and financial. We have clearly seen that in 2007-2008 with the subprime market meltdown. At the very beginning, it appeared that the crisis was going to be more contained in Europe. But then, what started as a private sector crisis quickly became a public sector crisis. Although, it was much more reluctant at the beginning, the ECB had to take a road very similar to the one taken by the Fed earlier. The problem is that both central banks have now very little margins to operate with nominal interest rate (their main operational target) so close to zero. Quantitative easing has allowed them to operate on long-term yields, but the positive effects are happening very slowly.
Since the 1970s, monetary policy has generally been formed separately from fiscal policy. Even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two policies separately. Don't you think the fiscal and monetary policies should be integrated and devised by one government entity, as they both have a direct impact on the economy?
I actually do not think so. Central banks should remain independent in taking decisions about monetary policy. Few decades ago this was not the case, even in developed economies. Central banks were at the service of fiscally irresponsible governments, and were therefore often required to print new money to finance unproductive government spending, in particular in pre-electoral periods. Unfortunately, this is still the case in many emerging and developing economies. Numerous empirical studies have clearly documented a strong negative correlation between the degree of central bank independence and the average rate of inflation in the economy. Granting central bank with institutional independence is crucial to reduce the risk of political monetary cycles, to keep inflation low and stable.
What we need is more coordination between monetary and fiscal policy. We need clear, transparent and enforceable fiscal rules within which fiscal policy can operate. These rules should be embedded in national constitutions to shield them by the frequent swings in ruling majorities that we have been frequently witnessed in many European countries. For instance, countries should put in place automatic adjustment mechanisms that reduce public spending (and therefore the size of public debt) during periods of expansions, to create room for action once a recession comes. Clearly, this is not what we have seen in southern Europe during the booms of the late ‘90s and the mid-2000s. Trying to make those cuts now, during such a prolonged and harsh recession is almost impossible.
For Euro Area countries this is obviously more complicated, as it would require a larger amount of coordination, not only with the ECB but with the other members. That's why, I think, the creation of a fiscal union - with a centralized fiscal government coordinating a Euro-area-wide fiscal policy with the ECB - is the next necessary step.