Dec 23, 2008 For Private Circulation only 1
Deepak TiwariResearch Analyst
deepakt@arthamoney.com
T: + 91 22 4063 3007
What should Obama do?
Unconventional problems require unconventional measures to solve them. This iswhat every government on the earth is doing right now. Several of them havealready announced stimulus packages while some of them are in the process ofannouncing yet another tranch of such packages. There are others that arecontemplating such steps to bolster the economy and restore the confidence ofconsumers, business and the public at large. The current financial crisis emergedin the US of A which is the one of major victims of its own misdeeds. So, naturallyall eyes are on the charismatic leader and President elect Barack Obama for hisactions once he takes the charge after entering in the Oval Office. Experts andeconomist across the globe are discussing what should be his immediate prioritiesand are speculating what steps he should take to produce the desired results. Inthis report, we will discuss what challenges Mr. Obama is going to face and whathe should do to tackle them?The US Fed has cut its interest rate almost to zero (0.25%). Soon the BoJ too cutits rate to 0.1%. The question is whether the zero rate regime can arrest theeconomic de-growth? Is it really a useful tool the central banks can use to derivethe desired result? The Fed has already begun an aggressive plan of QuantitativeEasing (QE) that has doubled the size of its balance sheet in just two months oftime span. As of now, banks are still hoarding on the cash and credit flow is yet toresume supporting the demand.Seriously speaking, this is a perilous and precarious situation. After exhausting allthe conventional measures to stimulate the economic growth being failed, the Fedis left with fewer options now. Japan which has been living with almost zero rateregimes for almost a decade recently cut its rate to 0.1%. So, what else thegovernments or central banks can do to bring the economy on the track? In thisreport, we will try to discuss what are the unconventional measures that can betaken to shore up the economy growth and whether they are effective at all?
Dec 23, 2008 For Private Circulation only 2
Mr. Obama and the world
One of the challenges Mr. Obama is going to face is handling current financialconvulsion and terrorism. Both of them have global impact and consequences.True, this is something Mr. Obama himself cannot do on his own, as it requires acoordinated and concerted endeavor from every corner of the world. However, hewill play a pivotal role and lead from the front. The success of this will dependmuch on how he manages the show. Some of the priorities that he will take up assoon as he takes the rein from his predecessor Mr. George W. Bush arementioned underneath:
Designing the new fiscal stimulus program which may amount to US $ 700billion to over 1 trillion.
Restoring and rebuilding confidence of consumers, investors andbusiness.
Chalking out quite extensive and tougher regulations for banks (limitingtheir risk taking abilities and overall banking operations), consumer lendingand investments.
Creating more jobs. It will be a major challenge for him because already in2008, over 1.7 million jobs have been lost and it’s expected that it willtouch 4 million in the coming year pegging the unemployment rate to over9%.
Announcing new economic legislations where the primary focus should beon doing whatever is necessary to get the economy going again.
Ensuring balance sheet cleaning up of banks and consistently increasingfunding for them.
Addressing the energy issue.The “Change” Mr. Obama will bring in will definitely change the mind-sets ofregulators and great American lifestyle. It’s expected that the new regime will dowhatever is necessary to stabilize the financial sector and get credit flowing onceagain. The previous $700 billion bailout was very badly handled. Now it’s yet to seehow the Mr. Obama and his retinue would handle the next stimulus package. Weexpect that the primary focus would be on spending on investments that offer long-term benefits in addition to the short-term benefit of stabilizing the economy. Themedia reports suggest that Mr. Obama has made his first priority to sign aneconomic recovery package with significant focus on infrastructure projects to helpboost jobs aiming at 3 million job creations over a couple of years.No doubt, few things will change for forever. Americans wont like to bank just uponcredit lines and will start saving for the future. It is pertinent to mention that in US,the savings rate is in negative for several years. And the banks too will be moreprudent and cautious in their lending policies.
Dec 23, 2008 For Private Circulation only 3
Unconventional monetary measures
After exhausting all the conventional measures to spur the demand and stimulatethe economic growth being failed, the Fed is left with fewer options now. It isexpected that the Fed will take some exceptional measures like QuantitativeEasing (QE) which is a tool of monetary policy also known as
printing money mechanism
. This is used usually to fight domestic deflation. Deflation is apersistent decrease in the general price level of goods and services only whenannual inflation is below zero percent resulting in an increase in the real value ofmoney - a negative inflation rate. All developed economies are in recession andare expected to see deflation by the second half of the next year. Inflation in theUS has pegged at 1.1%, in Japan 1.7% and in the Europe area at 2.1%. Theclassic example is Japan which has experienced unprecedented recession anddeflation for more than a decade. The Bank of Japan has been maintaining short-term interest rates at close to their minimum attainable zero values since 1999.However, it’s still debatable how these measures are effective to such deflationarysituations.
Under Quantitative Easing (QE)
, the central banks
inject
commercial banks withexcess liquidity to promote private lending, leaving them with large stocks ofexcess reserves, and therefore little risk of a liquidity shortage. It also involves
reducing
the reserve requirements and
buying treasury bonds
for cash to offsetthe reduction of money supply in the private sectors due to the collapse of creditthrough "open" market operations. Moreover they
buy asset-backed securities,equities,
and
extend the terms
of its commercial paper purchasing operation.
How the QE is effective in buoying the economy?
The Bank of Japan’s QE policy was introduced in March 2001 and terminated inMarch 2005. The policy was introduced with the intention to open-up a newpossibility for further monetary easing when the interest rate was already as low aszero. The policy was unprecedented and was an ambitious experiment by itself.The effectiveness of it has been a point of great controversy since its introduction.Several empirical studies have confirmed positive macroeconomic effect of the QEand have found out that the increase in the excess money led to the increase inaggregate demand and helped the economic recovery since 2002.
However, noeffect has been established on expectations and portfolio rebalancing byinvestigating the increase in Current Account Balance (CAB) targets and increasein government bonds purchases by the central bank. It’s very cumbersomeexercise to quantify the exact effect of such measures but the consensus is thatthey have positive effect on the economy.
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