THE GIST of Editorial for UPSC Exams : 14 March 2020 (Markets paying for the sins of central banks (The Hindu))

Markets paying for the sins of central banks (The Hindu)

Mains Paper 3:Economy
Prelims level: Central Banks
Mains level: Effectiveness of the monetary policies taken be central banks

Context:

  • When the US Federal Reserve began its quantitative easing during the global financial crisis in 2008, there were many who warned the Fed against embarking on this path, including the Reserve Bank of India’s ex-Governor, Raghuram Rajan.

Background:

  • More than a decade later, such voices have become quite rare.
  • Other central banks such as the European Central Bank, Bank of England and Bank of Japan joined the Fed in providing stimulus funding to revive their economies.
  • Many other countries slashed policy rates, bringing them to zero or even below.
  • Everyone knew that this could not go on forever, due to the excessive debt being accumulated by corporates, households and governments.

Unwinding the stimulus:

  • The other reason for unwinding the stimulus was to moderate asset prices that had been jacked higher by the easy money.
  • Financial markets, on the other ..........................................................

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Central banks in a fix:

  • Global central banks adopted two ways to ward off recession in 2008-09.
  • Like RBI slashed interest rates to multi-decade lows and some of the larger central banks began quantitative easing.
  • The Federal Reserve was the first to begin, in June 2008, making its balance sheet expand over four times by the end of 2014.
  • The Fed was also the most mindful about the negative impact of the QE programmes and after giving adequate notice to financial markets, began reducing its balance sheet as well as hiking rates from 2015.
  • The ECB and the BOJ however found it much harder to stop their stimulus funding or increase rates due to slow growth and very feeble improvement in inflation.

Fallout of easy money policies:

  • In its Global Financial Stability Report of October 2019, the IMF had stated, “The monetary policy cycle may have reached a turning point in major advanced economies, and the amount of global bonds with negative .................................................

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Interest rate options and market capitalisation:

  • According to the Bank of International Settlement, open interest in interest rate options increased 10 per cent in December 2019 to $61.5 trillion compared to December 2018.
  • The World Gold Council has also indicated a surge in futures and options contracts in gold since the beginning of 2019.
  • According to World Federation of Exchanges, total stock market capitalisation increased 22.85 per cent in the fourth quarter of 2019 compared to the same period in 2018, indicating a large inflow of money into equities as well.
  • In India, domestic mutual funds had been facing redemption pressures and had reduced their equity purchases, but foreign portfolio investors were firing on all cylinders last year; net purchasing $14.3 billion of equities in 2019.

Positions unwind:

  • While the debt financed by central bank funds will begin to hurt only when these are rolled over, it appears as if the trading positions are being unwound now.
  • This is apparent in the manner in which the euro and the Japanese yen, the two popular currencies for carry trade, spiked over 5 per cent since February 20.
  • Due to the ultra-low interest rates and the ECB continuing to print notes, the euro had joined the yen as the preferred currency for carry trades over the last few years.
  • Loans taken in these currencies are used to purchase assets across the globe or to take speculative positions in derivatives.
  • Since stock prices collapsed suddenly after February 24, those holding derivative positions financed by the carry trades would have been under pressure to sell their positions to cut their losses to repay the loans.
  • This is also the reason why the rupee, the US dollar and other currencies have become weak over the past few weeks.

Way ahead:

  • Everyone knew that assets prices were elevated due to access to cheap money and they also knew that there would be a shock once this crutch was taken away.
  • Most were however ...................................................

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Conclusion:

  • Central banks that have been in the forefront in providing stimulus funding may have few levers left at this juncture, given the already low interest rates and bloated balance sheets.
  • Other countries can, however, use a combination of monetary policy and counter-cyclical fiscal measures to support growth now.
  • It is hoped that once this crisis blows over, the central bankers would seriously rethink their policies and make course corrections.

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Prelims Questions:

Q.1)With reference to a report released by Network of Women in Media on sexual harassment at the workplace, consider the following statements:
1. The survey found that 36% of all respondents reported having experienced sexual harassment at the workplaces.
2. Of the respondents who experienced such harassment at work, 53% did not report it.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: ...................................

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Mains Questions:
Q.1)RBI’s monetary policy is based on targeting inflation needs reform. Comment.