The world should re-examine its current monetary policy model

To remain in operation, many financial firms need to borrow money on a daily basis. The market had dried up completely, the firms that had the cash, had it closed. The US Federal Reserve stepped in to provide some foam on the runway by printing money pumped into the financial system by buying bonds. It was expected to be one-sided. But soon, it became a regular thing and was called Quantitative Easing (QE).

In the first round of QE in November 2008, the Fed planned to print money and buy $600 billion worth of bonds. Another $600 billion second round was announced in November 2010. In September 2012, a third round was announced, with the Fed planning to buy $40 billion of bonds each month. This was a very unconventional way of implementing monetary policy.

Fourteen years later, the Fed is finally getting ready to withdraw some of that money. Therefore, it is worth looking at how monetary policy has changed.

Until 2008, central bankers largely tried to influence short-term interest rates. But through QE, the Fed lowered long-term interest rates by printing money and flooding it into the financial system, hoping people at lower interest rates would borrow and spend more, and companies would revive economic activity. To borrow and expand.

Soon, other rich-world central banks followed the Fed’s QE; Bank of England in March 2009, Bank of Japan in August 2011 and the European Central Bank in January 2015.

This made interest rates extremely low. When interest rates are low, people borrow and bring forward their future consumption and this spending inevitably drives growth. The prosperous world ended up relying too much on this formula. Therefore, continuing low interest rates that required continued money printing increased the size of the Fed’s balance sheet to $4.5 trillion at the end of 2014, from $905 billion at the beginning of September 2008. The Fed again took relief by printing more money.

This is when other central banks took over. As Edward Chancellor writes in The Price of Time: “In the two-and-a-half years after 2015… , central banks resorted to printing even more currency.

The frequent printing of money has resulted in massive mis-allocation of capital. When interest rates are too low, the present value of future cash flows increases. Theoretically, it also funds businesses that are expected to generate profit in a prospect in the future. This explains the huge growth of loss-making startups with valuations of one billion dollars or more.

It also explains the popularity of special purpose acquisition companies (SPACs), which are set up to raise funds through an initial public offering (IPO) to buy another company. At the time of an IPO, a SPAC is not required to state which company it plans to acquire or is conducting any other business operations for that matter.

As the chancellor writes: “SPACs … have been used to buy speculative ventures into the company for electric-vehicle technology, space travel, flying taxis, cannabis cultivation and ‘increasing humans to increase productivity and safety’.” it was done.” It is reminiscent of one of the South Sea bubbles in the early 18th century. Many companies came up with an IPO and, as Charles McKay wrote in the extraordinarily popular confusion and madness of the crowd, it involved “a company that ventures a great deal of profit, but no one knows what it is.”

Of course, low interest rates prompt investors to take higher risks to generate returns. It bubbled “in cryptocurrency and digital art, in luxury goods (supercars and Swiss watches) and household pets (cockapoos sell for $5,000 per puppy), and in collectibles (baseball and Pokémon trading cards)”, as well as bubbles in stocks. led. Bonds and real estate Given that the wealthy already owned many of these assets, they became wealthier and inequality in societies increased.

In addition, lower interest rates led to higher borrowings by almost everyone, including corporates who borrowed to buy back shares, increasing their earnings per share and stock prices. Governments borrowed to spend more. Data from the Institute of International Finance shows that as of March 2022, global debt stood at $305 trillion, or 348% of the world’s gross domestic product (GDP), up from 286% in 2007.

Therefore, the central bankers of the rich world focused on only one point, which was to drive growth by lowering long-term rates, completely ignoring the long-term negative effects.

Finally, the US Fed is now slowly withdrawing some of the money it printed. The size of its balance sheet has shrunk from a peak of $8.96 trillion to $8.79 trillion. But money printed by other rich-world central banks, running in trillions of units of their respective currencies, is still floating around. Obviously, we haven’t seen the last of it.

Vivek Kaul is the author of ‘Bad Money’.