Monetary Policy is dead! Long Live Monetary Policy!


Monetary Policy is dead! Long Live Monetary Policy!


During the great recession of 2008, developed countries that saw the weak aggregate demand as cause of the recession, adopted economic stimulus programs. This was the period of so-called “stimulus”. Everywhere it was about stimulating demand even China with its billion consumers felt obliged to encourage its consumption bomb. If this practice of the fiscal policy saved the developed economies, it has nevertheless created in the public accounts huge budget deficits. Today these economies experiment: 1. low interest rates and; 2. growth rates not strong enough to absorb 3. high levels of unemployment, 4. and rising inflation.


The academic world knows this story is not fiction. For those with short memories I’ll help. During the year 2000 the Fed (Central Bank of the United States) wanting to fight against rising inflation increased its rates from 6 to 6.05. The interest rates hike, which was indirectly addressed to curb inflation, will affect aggregate demand, and slow U.S. economy. Alan Greenspan who wanted to avoid the return of a recession convened a special meeting before the regular session in late January 2001. On January 3, 2001, the Fed unanimously reduces the rate to its initial level at 6%. Do not ask me what happened to inflation in the meantime? At the end of 2001 the interest rate will go down from 6 to 1.7%. This did not stop there because in mid-June 2003, the interest rate will reach the threshold of 1%. This example shows how the Fed did manipulate interest rates (successfully or not) to fight against the recession. Well those times seem to be gone and don’t expect them to come back so soon. Can we then rely on monetary policy to bring back growth?


Monetary policy in the U.S.


Monetary policy conducted by the Fed is simply accommodative. The central bank has maintained its interest rates at very low rate of 0.25% in an atmosphere where the recovery is slow and unemployment persistent. However, it has to give a clear message to the market. For how long will it continue to maintain these very low interest rates to stimulate weak demand? How should it deal with a certain increase in the rate of inflation induced by rising energy costs? There will come a time when the Fed should make a choice between curbing inflation and stimulate growth? In the case of the United States since December 2008, interest rates are fixed at 0.25% and it does not help the U.S. national savings. Indeed, the theory states that a monetary policy combined with long-term interest


rates near zero in an atmosphere of economic stagnation can be very dangerous. If currently an increase in interest rates seems unimaginable, Bernanke and his friends at the Fed must be imaginative. After injecting nearly 600Billions of dollars into the banking system, the banks do not seem to be very “excited” to facilitate lending. As a result real interest rates are then growing. In nominal terms too much liquidity in the market could therefore boost inflation.


Monetary policy in the euro area


The euro area shows a very interesting case. Before the troubles of Greece in this year, the European Central Bank was more active. Indeed, it has revised upwards its interest rates on July 13. They went from 1.25 to 1.50%. The reasons were simple! Any average student of economics can explain why! The recovery in Europe quickly occurred as not expected, with global demand driven by an increase in exports (especially in Germany). In this situation the price level in Europe began to increase. The central bank was therefore forced to push up interest rates to contain inflationary pressure on the markets. For this purpose the Governor of the Central Bank Jean Trichet boasted by saying that the euro area is the only one to increase interest rates. He said this ironically eying the Fed who has not raised its rates since 2007. Faced with the uncertainty of the situation in Greece, the European Central Bank by increasing it central rate shows it willingness to fight inflation. Experts anyway have expected that the ECB would raise interest rates in the face of rising inflation (up to 2.5%).


Monetary Policy in the BRICS (Brazil-Russia-India-China-South-Africa)


Emerging countries have indeed a more active monetary policy. They have the blessing to be able to use other tools, such as the change in reserve requirement ratio, the rebalancing of exchange rates, and the quantitative control of private credit. These countries are experimenting right now an accelerated recovery with high growth rates. In order to fight against the overheating of their economies, the BRIC and their central banks have increased several times their interest rates to fight against inflation. Between January 2010 and June 2011, the Central Bank of India has increased ten times its central rate from 3 to 6% reducing then inflation from 16 to 10%. Wednesday, June 6 The Central Bank of China raised for the third time the central rate. This should produce negative real interest rates in the markets and thus indirectly contribute to inflate consumption. The problem then remains! Brazil is struggling somehow to control its money supply by increasing interest rates on credit cards. The central bank rate was increased to 12.5% the highest among the BRICS. The newcomer in the group, South Africa and Russia are the only country to maintain their central rate unchanged at respectively 5.5 and 8.25%. the surge of domestic demand which is not inflationary, compared to that of other emerging countries, attests the good performance of the South African economy. The country may face inflation caused by a slight increase in production costs. As long as this is not widespread to the whole economy, the rate of the central bank of South Africa will remain unchanged for a long time.



1. Monetary policy in the United States has reached a situation of no return with a central rate close to zero without having driven the economic recovery! Can we say a requiem mass for monetary policy? Should we expect a magical “Greenspan effect oh sorry a “Bernanke effect” to save the U.S. economy? What will be the fate of monetary policy in case of default or not? Those are the relevant questions to be asked.

2. In the euro area the practice of monetary policy has recently become very cautious. The recent increase of the central interest rate is a response to a surge in inflation. The tightening should not be frightening! The ECB does not want to be surprise by the “events”. Beside, Europe should revive its fiscal policy while trying to save Greece, Spain, Ireland, and Portugal.

3. BRIC countries without South Africa have no choice but to use all the monetary measures to curb rising inflation without slowing too much growth.


Francis Konan


Economist, a graduate of the University of Economics and management of Vienna (Austria), a graduate of the Institute of studies advances Vienna (Austria), a graduate of the Faculty of Economics & management of the University of Abidjan (Cocody).



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