Unconventional Monetary Policies: Pros and Cons for the Economy and Society

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For decades, traditional monetary policy has focused on using interest rates as its main tool to achieve its goals in guiding the economy. In 2008, after the global financial crisis – which caused the so-called Great Recession – global central banks cut interest rates to zero or close to zero levels. Despite the fiscal stimulus and interest rate cuts that followed the crisis, economic growth rates did not recover much. After that, central banks resorted to expanding unconventional monetary policies, the most important of which is quantitative easing (asset purchase), as well as providing low-cost and long-term facilities and loans to financial institutions and markets, and clarifying future monetary policies. There has been talk at some point of the possibility of using negative interest rates. Central banks expanded the use of unconventional monetary policies “except for negative interest” during the global financial crisis, but they expanded more to advance global economies after the setback of the Corona crisis.

Conventional monetary policies use short-term interest rates to influence long-term interest rates. Long-term interest rates influence consumers’ and investors’ decisions to stimulate or discourage them. However, markets and financial institutions may not respond quickly and quantitatively to lowering base rates. That is why central banks, in case of recession, resort to using so-called non-traditional tools to provide more liquidity, support financial stability in the markets, and reassure financial institutions and stimulate them to lend. Unconventional means achieved good results in the global financial crisis, and also helped to get out of the Corona economic crisis, by providing credit and reducing its costs and risks, which raised aggregate demand and employment.

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On the other hand, the decline or decrease in interest rates may carry undesirable results. The low interest rate in a country compared to the rest of the world raises pressure on the exchange rates of that country, and it also pushes capital outflows. That is why the main central banks around the world are trying to coordinate their monetary policy and take convergent policies during global economic crises.

Unconventional expansionary monetary policies are considered to have other pitfalls, such as the possibility of their contribution to the laxity of some banks in taking the necessary precautions, which may expose the banking sector to some crises. Cases of this kind have recently emerged after central banks abandoned monetary easing policies. Therefore, the commitment of banks to take the necessary precautions to avoid severe stresses and collapses should be monitored. In addition, interest-cutting policies and accompanying liquidity provision raise competition among financial institutions, which puts pressure on banks’ profits. Many also fear that low interest rates will reduce credit costs and lead to inflation of asset prices, whether in the money or real estate markets, and generate financial bubbles or real estate crises over time, whose explosion will cause subsequent economic crises. On the other hand, low credit costs help the continuation of weak or inefficient companies and economic sectors. This may be acceptable in times of economic crises and high unemployment rates, but it slows down efficient economic transformations when the economy recovers.

Unconventional monetary policies may confuse monetary and fiscal policies. Asset-buying policies inflate central banks’ holdings of low-interest government bonds, which many consider a mere detour around money-printing policies. Quantitative easing advocates argue that bonds are purchased on secondary markets rather than directly from the government, which has to pay the value of the bonds when they fall due. On the other hand, low interest rates may encourage some governments to expand borrowing and raise national debt levels, generating debt crises over time, and may discourage central banks in the future from raising interest rates and reducing the use of unconventional means. A number of developing and developed countries, led by Japan and the United States, suffer from an unprecedented increase in the volume of national debt.

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In addition, some blame unconventional monetary policies for biasing towards the rich and harming the fair distribution of wealth and income in the long run. Policies to reduce the cost of credit help the wealthiest segments of the population to buy assets and drive up their prices, inflating their wealth faster. This consequently harms the fair distribution of wealth and income in societies. The rich benefit from credit more than the rest of the social segments, because they have the relationships, influence, financial solvency, and assets that enable them to borrow more, at easier terms, and at lower costs than the rest of the population.

Perhaps one of the most prominent effects of unconventional monetary policies is excessive stimulation of credit, which contributes to generating future inflationary pressures, as happened after the exit from the Corona crisis, and is still continuing these days. The deepening of inflation forced central banks around the world to quickly adopt tight monetary policies, and generated pressure on the banking sectors and prompted some of them to go bankrupt, as it rapidly raised government borrowing costs, and difficult financial and economic crises in a number of developing countries.

2023-06-04 08:00:35
#Pitfalls #unconventional #monetary #policies

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