Can Central Banks Stimulate Growth Without Inflation?
Image Credit: The Federal Reserve

Can Central Banks Stimulate Growth Without Inflation?


Anti-inflation hawks may be alarmed, but recently Japan, the United States and the eurozone have all launched massive pump priming operations aimed at stimulating growth.

The money printing has attracted the ire of Germany’s Bundesbank chief Jens Weidmann, who reportedly compared the European Central Bank’s bond buying to the “devil’s work”.

“If a central bank can potentially create unlimited money from nothing, how can it ensure that money is sufficiently scarce to retain its value?” he queried. On the 180th anniversary of Goethe’s death, the comments were in reference to the German artist’s Faust tragedy, in which the indebted Holy Roman Emperor is persuaded to print paper money backed by gold that had yet to be mined, with rampant inflation resulting.

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On Wednesday, the Bank of Japan gave Japanese politicians some of what they wanted by announcing an increase in its asset-buying fund to 55 trillion yen from 45 trillion, with its lending facility steady at 25 trillion. This boosted its overall quantitative easing program by 10 trillion to some 80 trillion yen in its protracted battle against deflation, with its official interest rate settings maintained in a range of zero to 0.1 percent.

Japanese markets applauded the move with the yen dropping and the benchmark Nikkei index gaining nearly 1 percent, while regional markets also advanced.

The move followed the U.S. Federal Reserve’s long-awaited decision to launch “QE3,” its third major quantitative easing program. The Fed will purchase $40 billion worth of mortgage-backed securities a month, keep interest rates near zero until 2015 and maintain its “Operation Twist” Treasury program, all aimed at reducing borrowing costs and spurring economic expansion.

Barely a week earlier, the European Central Bank answered the market’s prayers by promising to purchase the short-term debt of troubled member states, such as Italy and Spain, if market interest rates climb too high. German Chancellor Angela Merkel and Germany’s Constitutional Court endorsed the move, despite reported opposition from the Bundesbank’s Weidmann.

However, the money printing has also caused the U.S. dollar to weaken, giving export-led Asian countries a headache and reportedly fuelling an asset bubble in countries such as Hong Kong. Australia has also seen its dollar strengthen at a time of falling commodity prices, putting pressure on its central bank to reduce relatively high official interest rates amid slumping manufacturing, property and tourism sectors.

According to the Australian Financial Review, U.S. inflation expectations have reached their highest level since 2006 following the Fed’s QE3 announcement, at 2.73 percent.

Further asset buying by central banks may increase economic growth, but could also let the inflation genie out of the bottle, some analysts argue.

Gold usually benefits from higher inflation expectations and markets have already upgraded the forward price for gold to $1,793 an ounce, compared with the median forecast of $1,650 per oz for 2014, according to Bloomberg data.

According to Bank of America-Merrill Lynch, the U.S. Fed, Bank of Japan and Bank of England have primed the pumps by a combined $12 trillion over the past six years, taking their combined balance sheets to nearly $20 trillion.

Yet while inflation currently remains low in the U.S. and eurozone and non-existent in Japan, sentiment can quickly change and bond yields could start rising, increasing repayment costs for debt-laden developed countries.

U.S. economist Milton Friedman once famously quipped that deflation could be fought by “dropping money out of a helicopter,” a quote referenced by Fed chairman Ben Bernanke.

With $12 trillion already dropped, the central banks’ hope is that they have achieved this, and that economic growth will return fast enough to begin attenuating the sovereign debt burden. 

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