Global Monetary Policy as at 10 Sept 2012 ....

The Eurozone …

 

Peter Praet, the chief economist of the European Central Bank (ECB)’s highly-anticipated bond-buying programme was unveiled on 06 Sept 2012.

 

Draghi's plan, which has been coined Outright Monetary Transactions (OMT) could still provide a balm to the wounded financial markets and calm investors for the time being. It's now up to the governments to agree to the terms of programmes the fiscal and structural reforms and then implement them.

 

In essence, the OMT is a scheme that allows the “unlimited” purchases of sovereign bonds issued by troubled member states. The scheme comes with strings attached: borrowers will have to trim their fiscal deficits.

 

But balancing budgets at times like these could likely worsen the economic slump in the region's troubled member countries. As it is, signs are evident that the eurozone is heading for a double-dip recession by the third quarter of 2012 after three years of sluggish growth, while troubled economies, notably, the PIIGS ( Portugal , Italy , Ireland , Greece and Spain ), are already in recessions.

 

The ECB's bond-buying programme could help in a way by partially offsetting the harm from a contractionary fiscal policy (or austerity drive). And to pacify markets' concern, the OMT has a crucial feature: All the bond purchases will be “sterilised”. Technically, this means the ECB will absorb all the new liquidity generated from its bond-buying programme through other mechanisms to ensure that the volume of money in circulation does not increase arbitrarily.

 

In other words, there will be no “printing of money”, unlike the infamous quantitative easing (QE) programmes by the US Federal Reserve.

 

The US …

 

After Draghi, all eyes will be on US Federal Reserve chairman Ben Bernanke on whether he would do anything at all to prop up the sluggish US economy.

 

As far as the markets are concerned, Bernanke has been dropping hints of further easing of monetary policy since July 2012. So now (07 Sept 2012), the markets are crying for QE3, and expectations are high that Bernanke will launch it at the Federal Open Market Committee meeting during 12 -13 Sept 2012.

In late Aug 2012 Bernanke reiterated that “the Fed will provide additional policy accommodation as needed to promote a stronger economic recovery”. He said the institution remained open to various options, including QE3.

 

Certainly, another round of QE by the United States will have some negative side effects on the global economy, and there are quarters, who hope that the US Fed will refrain from “printing money” again.

 

For Bernanke, though, his view is that the costs of such policies “appear manageable”, so one should not rule out the further use of such policies if economic conditions (in the United States , that is) warrant.

 

The US Federal Reserve implemented the first round of its QE programme, worth US$1.25 trillion (RM3.89 trillion) from late-2008 through the middle of 2010. The second round, or QE2, which was worth US$600bil, was implemented from November 2010 through June 2011.

 

The controversial QE2 set off rallies in the global financial markets, and over the period of its implementation, led to the rise in global commodity prices. That's why some critics have blamed QE2 for 2011's high inflation, especially in Asia , and some even claimed that QE2 has played a role in sparking the Arab Spring.

 

Actually, the United States has little policy options left to boost its sluggish economy, which remains stuck with unacceptably high unemployment levels. Further fiscal spending seems out of the question, as the US government's debt is already approaching its mandated limit, so monetary tools seem to be the only more viable options.

 

The Asia …

 

For emerging economies like Malaysia , a highly accommodative monetary policy in developed economies, which has generated higher global liquidity, has led to higher capital inflows.

 

These inflows have resulted in significant strengthening of our currencies, rising asset prices, credit growth and, for some, overheating conditions in our economy.

 

Emerging Asian economies remained “vulnerable” to global financial shocks.

 

Indeed, the global economy has been to the brink and back a number of times over the past four years (2008-2011) because of different levels of shocks. The eurozone, for one, has presented many “make-it-or-break-it moments” with regards to the survival of its currency, and caused panicky moments to others.

 

While Asian economies have still been able to enjoy relatively healthier growth since recovering from the onslaught of the 2008/09 global financial crisis, there are rising concerns that the region could find it difficult to sustain the momentum amid the ongoing weakness of Western developed nations in a highly-correlated world.

 

With mounting evidence that China 's economy is already slowing, market observers are hoping that the country's policymakers would soon unleash huge stimulus measures to prop up its economy. China's growth is crucial to the region, as the world's second largest economy has become its neighbours' major trading partner in recent years amid slowing demand from Western developed nations.

 

According to economists, the key for Asia to pull ahead of the global economic uncertainties is to undertake structural reforms that could boost its institutions and promote domestic demand. This, they say, is a more sustainable way to promote growth in the region.

 

Emerging Asian economies has to implement an important policy shift to rebalance their economies and diversify their sources of growth and promote domestic demand, in particular domestic consumption. However emerging Asian economies are already changing from being export-led to turning to domestic demand as an important source of growth.

 

Conditions for the Western developed economies are unlikely to get better anytime soon despite their governments having almost exhausted all policy options to restore their economies.