Despite some apprehension that the two major central banks, the Bank of Japan (BoJ) and the US Federal Reserve that announced their monetary policy this week, would produce some surprises, they stuck to the script and delivered in line with market expectations. However, the decision not to surprise the market is not necessarily an unmitigated virtue and both have their share of problems.
The Fed that deferred its decision to hike the policy interest rate from this month to December is perceived by some to be losing credibility by adopting a slow-motion approach to monetary policy. Some believe it has become captive to the financial markets' whims and fancies. Instead of being a powerful central banker that can bring the markets to heel with the crack of its whip or the cliched raised eyebrow, it is seen to be led by the markets' leash.
This is not to deny the fact that the flow of data from the economy is indeed mixed and does not make a compelling case for an immediate hike. Inflation has risen a tad but the labour market has lost some of its traction. In such a situation, it might be sensible to stare hard at the data before taking a decision, but "data dependence" to an extreme degree could also be a euphemism for a certain kind of muddleheaded-ness and lack of confidence in its own ability as an institution to gauge direction of the economy and have faith in the strength of the economy itself. This is certainly undesirable.
Besides, the Fed is a divided house. Three of the 10 members, who voted in last week's meeting, wanted a rate hike in this policy itself. Yet of the larger pool of 17 voting and non-voting members, three advocate not hiking at all this year. This lack of consensus hardly helps in a situation of considerable uncertainty about the course of the economy. Thus even if a couple of data points are not up to the mark in the next couple of months, the Fed needs to hike the rate in December simply for the sake of its credibility.
The BoJ, on the other hand, is now grappling with the dark side of super-easy monetary policy. Japan's yield curve (the curve that plots yields of bonds of different maturities) is exceptionally flat. The 30-year Japanese government bond (JGB) offers a return that is just a little over 0.6 percentage points than the two-year bond. Financial institutions borrow short and lend long - a flat yield curve means their return on loans barely exceeds the rate at which they borrow and this squeezes margins. Thus, an aggressive easing policy is impinging on the health of financial institutions. Besides, an exceptionally low long-term yield is a signal that future growth and inflation are likely to be weak. This hardly helps an economy desperately trying to prime growth and fight deflation.
In its policy on Wednesday, the Bank of Japan (BoJ) reaffirmed its commitment to keep pumping in liquidity at its current pace. But instead of targeting the amount of money in the system, it switched to a target for interest rates to maintain a reasonable difference between long and short-term interest rates. Therein lies the rub.
For one thing, with over 25 per cent of all JGBs already on the BoJ's books, there might not be enough bonds going around for the central bank to buy. Thus, unless the BoJ keeps increasing the list of assets that it buys, continuing a heavy-duty quantitative easing (QE) programme might not be sustainable. Besides, targeting a particular interest rate or yield in this case could be an indirect way of suggesting that the BoJ would both buy and sell bonds. QE was a one-way street in which the central bank kept buying bonds. Thus, one could read interest rate targeting as a dilution of QE. It is not surprising that the yen appreciated in the wake of the policy. (More monetary accommodation should have entailed depreciation.)
With the Fed set to raise rates, the BoJ waffling and the European Central Bank in an introspective mood, we might just be seeing the beginning of the end of super-easy money policy. That unfortunately might not be good for capital flows to emerging markets including India.
Abheek Barua is chief economist, HDFC Bank. Bidisha Ganguly is chief economist, CII
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
