Date
25 September 2017
Federal Reserve chair Janet Yellen has hinted at a rate rise before the end of this year. But many factors may limit the Fed's room to tighten its monetary policy. Photo: Bloomberg
Federal Reserve chair Janet Yellen has hinted at a rate rise before the end of this year. But many factors may limit the Fed's room to tighten its monetary policy. Photo: Bloomberg

Will fiscal stimulus replace monetary easing as policy focus?

Although the market is closely watching the Federal Reserve’s rate decision, the climbing yields in major government bond markets may actually offer more important implications.

As we noted earlier, whether rates are hiked this month or not, the Fed would be fairly restrained in hiking interest rates.

This is so because hiking rates may push up the US dollar, weigh on prices of commodities and in turn hit emerging economies.

The high leverage of the US economy also limits the room for the Fed to tighten its monetary policy.

Meanwhile, US corporate earnings have seen a year-on-year decline for the fifth straight quarter, showing that the US economy is not that robust.

In that case, the Fed would be very cautious in hiking rates. Any action would be very moderate.

Otherwise, the US dollar may gain too much as other major central banks are still adopting a loose monetary policy.

In the meantime, it’s worth noting that yields of long-term government bonds in developed markets, such as 10-year government bonds in the eurozone, have been rising.

This indicates that the market seems to be questioning the effectiveness of monetary easing measures or even negative interest rates in stimulating economic growth.

It’s questionable whether extra-low or even negative interest rates would move capital into the real economy.

In fact, major economies have suffered from low growth despite years of extremely low interest rates.

It seems many countries have fallen into the so-called liquidity trap, where easy monetary policy has failed to spark borrowing and investment, thus having little impact on stimulating the economy.

Many developed economies have inflated their monetary base significantly in the last eight years, but their GDP growth rates have failed to catch up.

We’ve seen a similar picture in China. One yuan of credit could increase China’s GDP by 1.3 yuan in the second half of 2011, but the contribution dropped to 0.47 yuan in the second half of last year.

As monetary policy is not working, what else can be done?

The appearance of the word “fiscal stimulus” has become more often lately and its frequency surpassed “quantitative easing” for the first time since August 2010, giving us some hints as to what the market is expecting.

This article appeared in the Hong Kong Economic Journal on Sept. 15.

Translation by Julie Zhu

[Chinese version 中文版]

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RT/CG

Hong Kong Economic Journal chief economist and strategist

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