OF SUBSTANCE AND SPIRIT
By DIWA C. GUINIGUNDO
DIWA C. GUINIGUNDO
In our last column, we talked about the limits of central banks and monetary policy under certain circumstances. Under such an environment, monetary authorities can only move money around but such action would have no lasting impact on real sector activities.
Today, we argue that monetary policy and central banks are being assaulted left and right in different ways and in different forms.
During the Global Financial Crisis, their rampart was assaulted by economies and markets leaning heavily on it. Monetary policy was the only game in town. Fiscal space was severely limited so that only interest rates and monetary aggregates could be adjusted to achieve some action in the production sector. After a long, long period of patience, the US economy slowly dug itself out of recession and jobs were created and income started streaming in again.
Central bankers in Europe and Japan continue to rely on easy monetary policy to restart their economies in nearly negative interest rate territories.
Last year, monetary policy was blamed for some macroeconomic trouble in this part of the world including Indonesia and the Philippines.
While inflation was tame in President Widodo’s emerging economy, capital outflows bugged our close friend Governor Perry. He was forced to tighten monetary policy to stem the tide. Yet the markets could not understand him and in the process engendered negative sentiment that added more pressure to monetary policy.
In the Philippines, inflation hit decades-high levels and central bankers were blamed for running behind the curve. This should be read as “markets.” With some benefit of hindsight, and we assume 20-20 vision, inflation last year was indeed supply driven even as the IMF maintains some demand components were beginning to be important in the latter part of 2018. This is expected when oil prices rose 60 percent and the peso depreciated to be the most depreciated currency in Asia at some point last year. More expensive imports would drive prices high, the labor sector demanded and succeeded to secure higher-than-usual wage increases which were lost partly to higher transport fares, among others.
The Bangko Sentral ng Pilipinas did what it had to doas serious central bankers and practitioners of monetary economics.With an inflation process that was supply determined and later on characterized by insipient demand components, monetary policy was designed to be patient and respond as needed. It was equally difficult to overreact by an overly tight policy because of its impact on liquidity and credit growth and ultimately on economic performance.
Unfortunately, the markets were boisterous.
The markets were madding, with apologies to both Thomas Gray and Thomas Hardy, and indeed maddening, such that even monetary policy could not resist them. With all candor, we can say monetary policycould have been more prudent in dispensing those jabs and upper cuts. The other party was coming in seasonally and is expected to leave soon. Why push him out of the door when he was scheduled to leave anyway? Talking him into doing it early was smarter.
One should recall that in a time of negative market sentiment, the impact of monetary policy could be limited.
But you see, the markets sustained their calls.
Thus today, it seems monetary policy is on an automatic reverse mode. What was delivered last year was a 175- basis point increase and now that the economy is showing some slowdown, those 175 points may have to be redeemed. Our highly regarded economists at the BSP very well know the risks of an overreaction, of swinging to the other side on pricing risks and on overall financial stability. This is apart from the effects on the credibility of monetary policy and the central bank.
After all, the slowdown was not due to liquidity and credit conditions but to failure of Congress to pass the national budget on time and allow the National Government to spend on schedule. How does one expect more money and lower interest rates to add more fuel to economic growth? Inching towards zero or negative interest rate territory is equally dangerous!
Yet what is tragic is that the markets are now moving to reverse the strategy. They want more drops in policy rates, more reduction in the required reserves when limited production activities could very well render easy monetary policy useless and instead cause them to be inflationary. It’s good the other party has taken its leave together with lower oil prices and more stable peso.
But elsewhere, the assault on monetary policy and central banks continues.
For example, US President Trump last Monday tweeted that the US Fed should cut interest rates “by at least 100 basis points with perhaps some quantitative easing as well.” The US Fed was attacked as having “horrendous lack of vision by (Chairman) Jay Powell and the Fed.”
Meanwhile in Asia, Bloomberg survey shows some consensus among swap markets and economists that “central banks across emerging Asia are set to ease policy further.”
What is the assault?
The basis for the consensus is the observation that “the three month interbank rate was trading around 65 basis points above Indonesia’s seven-day reverse repo policy rate ahead of the July meeting and is now trading around 60 basis points above the new policy rate of 5.75 percent.” Ergo, there is basis for further easing.
In the case of South Korea, the movement in the forward swap is an increase from 18 basis points to 21 basis points. Markets interpret this as basis for doing another rate cut.
It is quite clear that whether market rates are higher or lower than the policy rates of the central banks, markets would still find some reason to say monetary policy should go up or down. In the first place, what happened to those interest rate differentials is a result of market expectationsthemselves that are data dependent. We all know there has been some deterioration in trade and investment prospects because of yes, negative sentiment from the pronouncements of both Trump and Xi. Secondly, what is so crucial about a lower differential of 5 basis points for Indonesia and a higher 3 basis points for South Korea? They are hiccups. And finally, if those differentials matter like between life and death, why would some economists argue for support from the fiscal side? Now they recognize that “effectiveness of monetary policy…boils down to the speed and extent of transmission and can only go that far in stimulating growth” particularly if demand is the source of the problem rather than, wait for this, the supply of funds!
Today, when the IMF sounded the call for caution and in the US a recession is widely expected, markets could only move for further easing. Unfortunately, central banks are drawn to listen to the sirens’ song.