Exchange Rates, Growth and Crises by A V Rajwade

Author:A V Rajwade
Language: eng
Format: epub
ISBN: 9789386643353
Publisher: Bloomsbury Publishing
Published: 2019-12-06T00:00:00+00:00

38. The G-20 Summit

The G-20 Summit earlier this month (November 2010) took place in the background of major domestic economic problems in the G-3—the US, the European Union and Japan—with slowing economies and huge fiscal deficits. President Obama had been weakened politically also as the mid-term elections, held just a few days before the Summit, had led to major gains for the Republicans who now have majority in the lower house of the US Congress. At least in theory, the Republicans are committed to simultaneously pursuing lower taxes and a balanced budget—which, prima facie, seem contradictory: in fact, the last 30 years’ history (Presidents Reagan and the two Bushes) suggests that, when in power, they manage to achieve the first but end up substantially increasing fiscal deficits. The October 2010 Global Economic Outlook report of the IMF has argued ‘fiscal consolidation needs to start in earnest in 2011’. The advice is perhaps more relevant to the US than to Europe; in the latter, fiscal consolidation has already begun in many countries. And, amongst the G-3, the Japanese economy seems immune, in terms of both growth and inflation, to both fiscal and monetary stimuli!

With little room for fiscal stimulation, the US Federal Reserve announced, in mid-October, another major program of Quantitative Easing (QEII). Since interest rates are as low as they can be, pumping money by purchasing government paper in the market is the only weapon left with the monetary authorities. The idea is to pump $ 600 billion in the market. Many analysts felt that QEII may lead to a fall in the external value of the dollar; the Chinese authorities criticised the US policy as a pre-Summit tactic to put pressure on China to allow its currency to appreciate more rapidly. Ironically, since the announcement of the QEII program, the dollar has appreciated against both the euro and the yen. And, the 10-year treasury security, which yielded just 2.5 per cent a month back, is now yielding 2.9 per cent! Both these developments could (more than?) take away whatever positive impact QEII was expected to have on growth and output.

Indeed, this strongly manifests the limitations of monetary policy in impacting macro-economic variables in the desired direction. To be sure, most modern central bankers acknowledge the limitations, and claim that they aim at shaping ‘expectations’; at dousing or rousing the ‘animal spirits’ of the economic agents. It is obviously not easy! The fact is that monetary policy can be far more effective in bringing inflation down by pulling the monetary string hard (as Paul Volcker demonstrated in the late 1970s/early 1980s), if only at the cost of recession. Pushing the string to get the opposite result is far less effective! The Federal Reserve’s problems have been compounded after the Republican victory: they are opposed to QEII as they believe it will ignite inflation—if only the cause and effect relationships were so consistent and predictable! One basic assumption underlying monetary theory—namely the constancy of the velocity of money—is certainly weak.

Meanwhile, the

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