Union Budget 2019: Monetary policy not enough

The central bank for all the world’s central banks - the Bank for International Settlements (BIS) - has gone on the offensive against unjustified criticism that a head-strong monetary policy of central banks was responsible for the global economic slowdown.

In its just-published annual report, Basel-based BIS contends that following the gains from a decade of extraordinary monetary policies that helped to restore global growth, there has been a slowdown in the pace of expansion since the last year. 

For the world economy to stay on course, other policies need to play a bigger role. Policy wonks must take a longer-term view, it suggests bluntly, lamenting that monetary policy alone could not do the heavy-lifting. 

BIS general manager, Agustin Carsten, put it candidly when he said that a better mix is needed between monetary policy, fiscal policy, macro-prudential measures and structural reforms. Macro-prudential tools range from system-wide stress tests and counter-cyclical capital requirements to maximum loan-to-value and debt-to-income ratios.

Stating that monetary policy alone cannot become the engine of higher sustainable economic growth as it works better as a backstop, Carsten picturesquely said that to look past the clouds to spot the blue sky, a plane cannot only fly on a single-engine! 

Amplifying this point, the report says that while authorities can help where space is available, fiscal policy needs to be used judiciously to boost sustainable growth, supporting aggregate demand. It believes that the composition of spending needs to be growth-friendlier, especially by boosting well-chosen infrastructure investments. 

In the process, it is crucial to preclude the trap of carrying out pro-cyclical policies. It is, however, best to undertake structural fiscal reforms like reducing the bias of tax systems in favour of debt. Nirmala Sitharaman, presenting her maiden Union Budget in a couple of days, may benefit from this advice. She must persuade her officers in the North Block not to view Mint Street officials as adversaries.   

Referring to operations of the financial system, the report maintains that all over the world, banks face the challenge to improve profitability. Costs remain stubbornly high, relative to income. Business models have yet to be restructured on a sustainable basis—in particular, adapting to a lower and flatter yield curve. 

Banks are also facing increasing competition from non-traditional players such as big techs, who are taking advantage of digital innovation. 

There is also the negative impact that historically low interest rates in advanced countries may have on financial intermediation and credit supply. Over the longer term, low rates tend to sap interest margins, profits and hence banks’ ability to build up capital, which is essential for their lending to the productive economy.   

The report singles out praise for inflation targeting frameworks in emerging market economies, including India, which have generally been successful. These frameworks have been combined with varying degrees of foreign exchange intervention, coupled with the active use of macro-prudential tools.

Interestingly, the BIS report focusses especially on the entry of large technology companies such as Facebook, Amazon, Alibaba, Google and Tencent, into financial services. These firms have already established platforms in their respective businesses, such as in e-commerce or special networking. 

The business model of big tech firms rests on enabling direct interactions among a large number of users. An essential byproduct of their business is the stock of user data. The data is then utilised as input to offer a range of services that exploit natural networks, generating further user activity, which then completes the circle, as it generates yet more data. Big techs can glean additional data from their own ecosystems in social networking, search engines and e-commerce that are outside the financial services they operate. 

Since data has increasing returns to scope and scale, big techs will be able to make far more effective use of any incremental data. It is small wonder that Facebook recently outlined its intent to upend the financial system through the launch of Libra, a ‘global digital currency’. 

FB has touted Libra as a means to improve financial inclusion for the world’s 1.7 billion people without access to bank accounts. Amazon, which lends to companies, contends that it wants to fill the gap left by banks increasingly reluctant to lend to small businesses.

While acknowledging the potential benefits of big techs entering the financial system with their superior customer data and efficient decision-making, which lowers barriers to the provision of financial services to the unbanked and bypassed sections of society, BIS has also raised concerns over the potential misuse of that data. This it said, would spawn, ‘adverse, economic and welfare effects”. Firms could, for example, exclude high-risk groups from socially desirable insurance markets by working out the maximum rate a borrower would be willing to pay for a loan. 

Finally, the report is right when it argues that wide access to data could, in principle, be beneficial. Digital data can be used by many, including competitors, without loss of content. Besides, since data is obtained at zero marginal cost as a byproduct of big techs’ services, it would be socially desirable to share them freely.  Provided that markets are competitive, open access to data can help to lower the switching costs for customers, alleviate hold-up problems and generally foster competition and financial inclusion.  

This is easier said than done and in the face of the rapid and global digitisation of the economy, coordination

(This article was originally published on The DNA. Read the original article)

(Disclaimer: The opinions expressed above are the personal views of the author and do not reflect the views of ZMCL.)