The Nobel Prize in Economics has gone to Ben Bernanke, Douglas Diamond and Philip Dybvig for work done in banking. While the latter two have been academicians, the first has also held the most important position of Chairman of the Federal Reserve. The subject for which the prize has been awarded is for banking and finance with bankruptcy as a supplement. While theory and approach to solve financial crises cannot be contested as they add to the wealth of literature, Mr Bernanke’s name also raises some further questions in the context of the present crisis as there is an unfinished agenda.
While he was credited with the Quantitative Easing (QE) programme which helped the system, there have been several other consequences which have caused considerable distortions in the global financial system for over a decade now. This leads to the conclusion that while his solution was unique, it has become harder to exit without causing substantial disruption. What exactly is the argument?
Mr Bernanke was also known as Helicopter Ben, as he had advocated in 2002 that money be poured into Japan to revive the economy. The analogy was for a helicopter to fly by and drop currency which could be spent to drive the economy out of a recession. This is similar to what John Maynard Keynes had advocated where people were paid money to do mundane jobs. But it is different because when money is provided by central banks to players the consequences are dissimilar to the effects of individuals spending more due to government payments. But is this the most prudent way out?
The idea of QE was compelling then and also alluring today, as the same was persisted with when Covid struck and the world was in a phase of lockdown. Central banks vowed to ‘do everything’ to support growth which meant lowering rates to zero and persisting with funding. But as a central banker, he had brought in the concept and used it effectively. But, it was the first part of the story which was left to other central bankers to take to the logical end.
Two issues however remain nagging in the critic’s mind. The first is the unintended consequences of such easing. And the other is the struggle for subsequent chairpersons to get out from this easing.
Pumping in more money through buyback of various kinds of securities on a large scale did infuse liquidity. But, it did not all get used in the US and a large part of these funds were invested in the emerging markets. In fact, the US economy has still to get back to the pre-Lehman days which is now 14 years ago. This strategy helped to brighten up the stock indices in all the recipient countries and they enjoyed the benefit of running high balance of payments surpluses. India too benefited from the same through the FDI and FPI routes. This posed other problems for central banks which had to sterilise such flows, and inflation became an issue as money supply increased.
This approach was followed even during Covid times in India where the focus was on providing liquidity to those who required it. Hence we had the long-term repo operations (LTRO) where specific sectors were targeted. This was followed by GSAP (government securities acquisition programme) where the RBI bought securities from banks in return for liquidity. ECB, Japan, Bank of England and several other central banks followed suit. This was done even though the lending capacity of banks was low and borrowers few. Often these funds were used to repay expensive loans.
Here comes the second challenge for central banks. Stopping the QE and changing it to tightening has always been a problem for global markets. One can recollect the taper tantrums that shook stock, currency and bond markets all over when it was expected that the Fed would roll back the QE programme. Stock markets crashed at this prospect and investors started to sell when this announcement was expected. The bond market goes into a tizzy as prices fall and yields rise every time the Fed talks of QT. These movements involve a lot of money.
Similarly reducing interest rates to close to zero is a good strategy in crisis times which also got replicated during covid. But moving back to saner or normal levels become a worry for everyone as everything done by the Fed or ECB has ramifications for all countries. With globalisation now fully set, all Fed actions permeate the policies of other countries too as rates have to keep pace to ensure that investment does not migrate outwards.
Getting out of the quantitative syndrome is hence a major challenge for the Fed in particular. The RBI has managed to do so primarily because the amounts involved are lower and these funds have moved to either lending or government paper (as the government borrowing programme has topped Rs 13 lakh crore for three successive years). For the Fed and ECB they have moved overseas.
A question really is that when bestowing the Nobel Prize especially to a practitioner, should the consequences of a policy that was successful in its time in terms of immediate impact also be a consideration? Mr Bernanke surely has made a mark as an academician, but there is an unfinished agenda in one of his more talked of polices, QE. This has not mattered in this case, but should it?
Madan Sabnavis is Chief Economist, Bank of Baroda and author of ‘Lockdown or economic destruction?’ Views are personal
