Tags: Roubini | Fed | QE | severe

Roubini: QE Side Effects Could Be ‘Severe’

By    |   Monday, 04 March 2013 12:03 PM

Although quantitative easing (QE) has short-term benefits, if it continues its long-term costs may be severe, warns Nouriel Roubini, a New York University economics professor, in an article for Project Syndicate.

If QE postpones deleveraging in the private and public sectors too long, it may create “an army of zombies: zombie financial institutions, zombie households and firms, and, in the end, zombie governments,” Roubini says, calling for it to be phased out over time.

Roubini, chairman of Roubini Global Economics, questioned the effectiveness of ongoing QE. Bond yields are already low and banks are hoarding liquidity. Prime corporate and household borrowers don’t want or need to borrow, and those who need to borrower cannot.

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Inflating stocks only works in the short term if growth fails to recover. “And the reduction in real interest rates via a rise in expected inflation when open-ended QE is implemented,” he warns, “risks eventually stoking inflation expectations.”

In addition, he writes, weakening the dollar to increase exports won’t work if other central banks also pursue QE. It becomes a zero-sum game, resulting in “‘QE wars’ as proxies for ‘currency wars.’”

It also leads to excessive capital flows to emerging markets. Emerging markets then face the threats of inflation or asset and credit bubbles on one hand, and declining competiveness and rising external deficits on the other.

Moreover, ongoing QE can lead to asset bubbles both here and abroad in equities, housing, commodities and bonds, Roubini explains. QE can create a moral-hazard danger by weakening governments’ incentives for economic reforms.

Exiting QE will be tricky, he adds. If done too quickly, interest rates could spike, chocking off recovery.

“Eventually, excessive inflation may erupt, or credit growth may slow, rather than accelerate, if banks — faced with very low net interest-rate margins — decide that risk relative to reward is insufficient,” he says.

“In short, policies are becoming more unconventional, not less, with little clarity about short-term effects, unintended consequences and long-term impacts,” Roubini says, warning that side effects could be “severe.”

While many experts have warned about QE creating asset bubbles and future inflation, Fed Chairman Ben Bernanke has downplayed those concerns.

“To this point we do not see the potential costs of the increased risk taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation,” Bernanke said in recent testimony to Congress.

Still, he said the Fed takes risks of financial instability very seriously.

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Economy
Although quantitative easing (QE) has short-term benefits, if it continues its long-term costs may be severe, warns Nouriel Roubini, a New York University economics professor, in an article for Project Syndicate.
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2013-03-04
Monday, 04 March 2013 12:03 PM
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