Tuesday 6 September 2016

Dilemma of the Central Banks: To push further NIRP?

Dilemma of the Central Banks: To push further NIRP?

There's no Zero Lower bound for Nominal interest rates. If you think Capitalism is in danger because of this sudden realisation, then unfortunately, it is too late a realisation. Realisation should have dawned earlier when Deflationary tendencies swept gradually across Japan, US, wide swaths of the EU and Governments left the job of resuscitation to Central Banks without taking any onus to timely rescue their respective economies in the fiscal sense of the act.

So now that the damage has been done, what is the way out of this? Glibly blaming NIRP(Negative Interest Rate Policy) is the easiest way out. NIRP is the symptom. Not the cause. Blaming the symptom is like saying your cough is to blame for the illness you have and not that virus that is causing the cough in the first place.

Banking Reforms
Japan had a Banking problem right from its Chaebol like cross holdings of its banks with its large corporates. US had a banking problem in a great many ways that are well documented leading into 2008. EU has a festering Banking problem which is in part also related to its ill conceived Currency/Monetary Union without a fiscal union in place.

So most of these negative interest rates issues actually arose from a faulty banking system and erroneous structures and incentives in place in all these jurisdictions facing this issue. That's the underlying cause. Don't just blame the symptom.

Spain and Ireland have done well to try and reform by setting up effective Bad banks and resolution mechanisms. Other nations such as Italy, France and even Germany should immediately start on the path of reforming their Banks. Japan has to reform its banking ownership structure- Big borrowers cannot also be owners of banks.

RBI outgoing Governor Raghuram Rajan has laid out a fairly full agenda for reforming the banking system in India. Missing is the bad bank piece which would gradually come about along with the other reforms that the RBI alongside the Indian Government is pursuing vigorously.

So should ECB and the BoJ cut rates further? Should they continue to expand their Balance sheets by way of commitment to more QE? It would be wonderful if the EU Council supports Governments such as the one in Italy to commit more to Fiscal support to their hard pressed economie. Secondly Banking reform must be carried out by Italy, France and Germany to fix the credit flow to the real sectors of the economy. NIRP and QE will work when both these issues are sorted out. Standalone QE and NIRP will not work. They must go hand in hand with Fiscal resuscitation and urgent Banking reforms.

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