The Negative Side Effects of Loose Monetary Policy

February 7, 2015

In as recent speech to the Bank of International Settlements, Stephen King, Chief Economist at HSBC, highlighted the following perils associated with excessive reliance on loose monetary policy to stimulate global economic growth.

 

  • Rapid and inappropriate increases in other asset prices: loose monetary policy depresses interest rates, which lowers the level of risk-free return required by fund managers. This can result in excessive investment in assets such as real estate and stock markets.

 

  • Uncertainty in currency markets: huge increases in money supply can drive exchange rate devaluation, which supports exports but transfers deflation and recession to other economies. 

 

  • Easy monetary policies may allow inefficient companies to survive and halt new competition: effectively subsidising weakly performing, poorly managed companies can contribute to overcapacity and may stop new competitors from entering markets.

 

  • Low interest rates trigger a hunt for yield, which can destabilise asset markets: similar to to the first point, fund managers get extra fuel to scour the globe for asset returns, with spillover effects on financial markets. 

 

What can governments do in the present scenario? According to King, central bankers need to take a broader view of the economy, rather than looking at inflation and output indicators.

 

A wider look at the state of the economy, including asset price levels and signs of over leverage in the financial sector, will give a more nuanced read of economic conditions and, possibly, prevent future economic crises.

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