Myths of monetary policy divergence
THE RECENTLY observed monetary-policy divergence between the United States and the European Union was, more or less, triggered by the current transformation of the global economy.
This global transformation into new-normal growth was mainly initiated by China’s sluggish economy and geopolitical conflicts in various regions. The reason the US Federal Reserve raised its federal funds rate in December was the positive signs of employment recovery in the United States.
The European Central Bank (ECB), conversely, needs to extend its quantitative-easing (QE) policy with the aim of reaching its inflation target of 2 per cent. European countries are also busy with other urgent problems, ranging from a debt crisis in Greece to refugee and terrorism crises.
Hence the main question of concern is, will monetary-policy divergence affect global economic growth negatively? The answer is probably not.
First, the previous QE measures of the ECB can stimulate growth to only a limited degree. This may be for several reasons, such as the need of some governments to increase their tax rates, which works against the effectiveness of monetary policy. Existing regulations also tend to reduce the effectiveness of monetary policy, and household debt is too high for many to qualify for new loans.
Second, the Fed may not be able to raise its federal funds rate easily in the future because inflation is still low, and future inflation is also expected to be low because of the world oil-price slump. The above two arguments imply that monetary-policy divergence is not a real threat to the global economy. The real threats to the new-normal global economy are market concerns over a real contraction of the Chinese economy, and the Chinese government tackling long-term problems instead of being fully occupied with short-term ones, as well as increasing risks related to geopolitical disputes in different regions of the world.
These concerns create psychological effects that cause markets to overreact to changes in policy directions from the Fed and the ECB. Hence investors who are able to distinguish fundamental truths from policy myths should be well prepared for more productive investment opportunities, since they do not overreact to policy changes during this period of new-normal global growth.
Professor Arayah Preechametta is a lecturer at the faculty of economics, Thammasat University.
