x Abu Dhabi, UAESaturday 20 January 2018

Putting QE2 into reverse will stop inflation surging

Sir Andrew Large, a former deputy governor of the Bank of England, says there is some uncertainty about whether the US Federal Reserve's second round of quantitative easing since the global financial crisis will succeed in bolstering economic growth.

Sir Andrew Large, a former deputy governor of the Bank of England, says there is some uncertainty about whether the US Federal Reserve's second round of quantitative easing since the global financial crisis - dubbed QE2 - will succeed in bolstering economic growth, as well as combating deflation and high levels of unemployment in the US.

While it is also unclear what kind of economic impact QE2 will have domestically, Sir Andrew has expressed concern that QE2 might instead result in significant monetary outflows from the US to emerging markets, which have already seen "very big increases in foreign exchange reserves".

On November 3, the Fed announced it would buy US$600 billion (Dh2.2 trillion) of longer-term Treasury securities in the open market over the following eight months. The US central bank is striving to fulfil its dual primary mandates of achieving maximum sustainable employment and its informal price stability inflation target of between 1.75 per cent and 2 per cent.

US unemployment remains persistently high, reaching 9.8 per cent last month, while inflation is at the slowest pace on record at less than 1 per cent.

That is despite the Fed's earlier injection of $1.7tn into the global financial system to avert a worldwide economic depression.

Furthermore, banks remain unwilling to lend despite sitting on reserves of more than $1tn, capitalised by the Fed's purchases of treasuries and mortgage-backed securities between December 2008 and March this year.

While conceding that the Fed's primary mandates necessitate its quantitative easing actions, Sir Andrew nonetheless has "some reservations" about them.

Asked whether inflation was a real concern, he suggested the idea that a little bit of inflation to reduce the US debt burden "might well be a twinkle in a few policymakers' eyes".

"Will quantitative easing lead to inflation? The answer is maybe," Sir Andrew told INSEAD Knowledge in Singapore last month.

"On the other hand, I don't think one should overlook the fact that the Fed can easily reverse the policy stance if they think that inflationary expectations are rising too quickly.

"So I don't think that just because they have done this it means that inflation's an inevitability."

However, Sir Andrew believes Germany is right to "point out the dangers" of printing money and pumping it into the economy, bearing in mind the hyperinflation experienced in the Weimar Republic after the First World War.

"It's seared in the German consciousness and I think one respects that," Sir Andrew said.

"I do think that the dangers are perhaps slightly overstated, given the possibility the Americans have to withdraw the stance they are taking."

The dollar has been weakening against a basket of currencies since June, fuelling talk of a currency war.

Limiting his comments to the recriminations between the US and China about currency manipulation, Sir Andrew saw good reasons in the US wanting to devalue the dollar, as well in China delaying the rise of its currency.

"The Americans obviously would like to see the [yuan] significantly stronger. It's all about jobs in the states, effectively," he said.

"The Chinese, on the other hand, are concerned in two senses. One, I think they themselves are the recipient of a large amount of the liquidity that's been created, but the other is that if they were to revalue the [yuan] too rapidly, it could give rise to social unrest in China itself, and they clearly are very worried about that.

"So you have two points of view here, and it's very difficult to know how to reconcile, and to a large extent I think it is a matter of timing. There's little doubt that the Chinese can see the validity of the argument that over time the [yuan] should adjust. Equally, they need time to make sure that the social cohesion can hold together."

Is the time right then for a return to linking currencies to a gold standard? In an article in the Financial Times last month, Robert Zoellick, the president of the World Bank, called for a return to a modified gold standard, a system in which the monetary unit is a fixed weight of gold.

"I don't know the answer to that," Sir Andrew said, adding he doubted that many people, including Mr Zoellick, thought there would be a return to a gold standard. Another scenario, Sir Andrew said, was that gold could be included in a basket of currencies, which would be "a less extreme solution".

Even so, he has "significant doubts" about it gaining international acceptance.