Raghuram Rajan, India’s departing central banker, warns that low interest rates globally could distort global financial markets and will be difficult to abandon.
Many nations around the globe, including the United States and Europe, have kept interest rates low as a way to spark growth. But such countries could become “trapped” by fear that when they eventually raised rates, they “would see growth slow down,” he told The New York Times.
Low interest rates should not be a substitute for “other instruments of policy” and “various kinds of reforms” that are needed to encourage growth, Rajan warned the Times. “Often when monetary policy is really easy, it becomes the residual policy of choice,” he said.
To be sure, CNBC’s Spriha Srivastava agrees that global financial markets “are currently riding on the wave of uncertainty and speculation over whether the world's central banks will continue to pump in more and more cash into the economy though bond-buying programs known as quantitative easing (QE).”
Alberto Gallo, head of macro strategies and manager of the Algebris Macro Credit Fund, describes this paradox as "QE infinity," whereby low rates and seemingly endless rounds of bond-buying programs encourage cheap borrowing, and investment in financial markets -- but not in the real economy.
"The problem is rising debt and monetary easing comes with many collateral effects. One is the distortion of asset prices, leading to asset bubbles," Gallo explained on his website.
"Asset price distortion also has a ripple effect on wealth distribution, increasing inequality by benefitting the already-wealthy who are more likely to hold financial assets. Over time, low rates and QE can also encourage misallocation of resources to leverage-sensitive sectors, including real estate and construction."
For her part, Federal Reserve Chairman Janet Yellen apparently thinks the central bank “can achieve with a mix of forward guidance about the future path of interest rates and quantitative easing while preventing rates from slipping below zero,” the Financial Times explained.
In her recent Jackson Hole, Wyoming, speech, Yellen cited an academic study which “concludes that, even if the average level of the federal funds rate in the future is only 3 percent, these new tools [forward guidance and QE] should be sufficient unless the recession were to be unusually severe and persistent.”
Studies have found “that our asset purchases and extended forward rate guidance put appreciable downward pressure on long-term interest rates and, as a result, helped spur growth in demand for goods and services, lower the unemployment rate, and prevent inflation from falling further below our 2 percent objective,” she said.
“Despite the lower bound, asset purchases and forward guidance can push long-term interest rates even lower on average than in the unconstrained case (especially when adjusted for inflation) by reducing term premiums and increasing the downward pressure on the expected average value of future short-term interest rates. Thus, the use of such tools could result in even better outcomes for unemployment and inflation on average,” she said.
“In addition to taking the federal funds rate back down to nearly zero, the FOMC could resume asset purchases and announce its intention to keep the federal funds rate at this level until conditions had improved markedly–although with long-term interest rates already quite low, the net stimulus that would result might be somewhat reduced.”
(Newsmax wire services contributed to this report).
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