Monetary policy risk losing its effectiveness

WHILE expecting the global interest rates to drop further as we move into 2020, the risk for global economy to weaken steeper is more likely than expecting a synchronised recovery.

Downside risk to growth comes from political issues that will influence global relations. The Us-china trade war, which remains in the centre stage has raised fears of a currency war. It has also fuelled deglobalisation as countries and firms can no longer count on the long-term stability of integrated value chains.

Besides there is the Us-china technology war where both are vying for dominance over the industries of the future like artificial intelligence (AI), big data, robotics, 5G, and many more.

Risk of debt and financial crisis as well as geopolitical tension are still high on the cards. These issues risk disrupting global supply chains and can trigger stagflation – a condition of slow economic growth and relatively high unemployment, or economic stagnation, accompanied by rising prices or inflation. It can also be defined as inflation with a decline in economic growth.

Earlier business optimism about continued global growth has been replaced by worries about a sudden downturn. Their confidence has been shattered by the ongoing global issues like trade and currency war, geopolitical risk, disorderly Brexit and risk of a slower than expected growth.

Besides, global business is operating at a new low, possibly due to the impact from an intensified and lengthy period of cheap money with the still-unsatisfactory state of public sector balance sheets. In addition, the automobile industry is contracting owing also to a variety of factors, such as disruptions from new emission standards in the eurozone and China that have had durable effects.

Companies in the United States, Europe, China and other parts of Asia have reduced their capital expenditures, damaging investment and demand for capital goods. The global tech, manufacturing and industrial sector is already in a recession. Orders and inventory have fallen. Nonetheless, it has not fully dragged the global growth into a slump because of services which is still holding up. However, when consumer confidence takes a hit, it will likely drag services and tip the global economy into a sharper slowdown or recession.

Another issue flaring the business risk is the extreme weather events and natural catastrophes. The likelihood of an increased incidence of costly and disruptive events has brought these environmental risks into focus. Today, many companies are focusing on sustainability. However, it is time for businesses to put a greater emphasis on climate resiliency – a focus that is essential to adapt and succeed in the era of unpredictable weather.

Climate resiliency rejects the concept of business as usual and focus on continuous transformation. Building climate resiliency leads towards a circular economy. It needs to ensure we have the amount of quality resources we need to support our growing global population while business leaders must develop resiliency in the key areas like (1) leveraging innovation in the form of new materials, services and solutions throughout supply chains; (2) convert raw materials into products more efficiently so we are less dependent on them; and (3) effectively retain and invest in the human capital needed to operate successful businesses

The question, then, is whether monetary policymakers are prepared? Focusing on the monetary solution to address the next global recession or slowdown will most likely be immune. While cheap money may fuel asset bubbles, it is unlikely to save the global economy from slipping into a sharper slow down or recession. With the risk of a drop in aggregate demand in the near term remains high, it is logical for central banks to ease their policy rates.

Also, there is an important difference between the 2008 global financial crisis and the risk of negative supply shocks that could hit the global economy today. The former was mainly due to negative aggregate demand shock that depressed growth and inflation. And so, it was appropriate to use monetary and fiscal stimulus. But this time around, the world will most likely be hit by adverse supply shocks. The policy response will have to be different.

Using the monetary policy to address the damage will be tough and not a sensible option. Lesson from historical experiences is that central banks can ease monetary conditions all they want, but they cannot force people to use easy money. People may not borrow and spend if it is not economically rational to do so. If consumers or businesses fail to see a positive benefit in borrowing money and using it to invest or spend, they will not despite how cheap the money is.

Simply put, the monetary policy has lost its effectiveness at this point. It does not address the fundamental weakness, which is the lack of final consumer demand. The so-called “strong economy” of post 2008 global financial crisis is lower compared to the period prior to the 2008 crisis. And the danger of lowering rates is that it could fuel asset bubbles and drive up the prices of stocks and bonds while encouraging risky borrowing. It sets the stage for the collapse in the financial markets just like we saw in 2008. If that happens, it will lead us right back to an economic downturn and deflationary pressure, a scenario we saw in the 1990s in Japan and the United States after 2008.