Following the bursting of the stock market bubble, central banks in the major industrial countries massively loosened monetary policy, ratcheting key interest rates down to their lowest level in 40 years in some instances. This subsequently spawned a correspondingly steep rise in Iiquidity around the globe. The liquidity supply got way ahead of nominal economic output, resulting in a liquidity overhang which could have an inflationary impact or give rise to further bubbles on the asset markets (bonds and/ or real estate markets). Alongside the traditional credit channel, excess liquidity was also fueled by the interventions of Asian monetary authorities in the currency markets. The pronounced tendency to prop up one's own currency against the dollar has countervailed a reduction in global imbalances - as evidenced first and foremost by the persistence of the US current account deficit.
Global liquidity glut: problem or growth driver?
The global trend in liquidity has contributed to a series of unusual constellations on the financial markets and in the monetary economy. Among these are the fact that, stateside, long-term interest rates have barely reacted to the Fed's tightening while the euro area has seen a sharp drop in the velocity of money in conjunction with unusually low longterm rates. To some extent at least, monetary policy of recent years is Iikely to have contributed to these aberrations, particularly as low key rates have paved the way for extensive carry trades.
The extent to which the current liquidity overhang represents an Inflation risk will hinge on whether self-reinforcing wage-price spirals emerge. However, given the ongoing impact of globalization, which severely restricts the wage scope of both suppliers of labor and of companies operating on the global stage, this risk is not pronounced compared with the 1970s. Even a surge in commodity prices is unlikely to be sufficient to trigger such an outcome.
As for the question what conclusions monetary policy should draw from liquidity growth, we ultimately have to rely on theoretical notions of how monetary policy worlcs. There is much to suggest that the monetary impulses of recent years will feed through into the real economy, as we have already seen in the USA. For this reason, the tightening of monetary policy in America is logical and a rate cut by the European Central Bank unlikely. From a conceptional angle, the sharp price changes on asset markets, driven not least by interest rates and liquidity, argue for a longer-term orientation of monetary policy. Shifts in asset prices simply cannot be encompassed with short-term explicit inflation targets. Moreover, recent years have highlighted the importance of credit growth for monetary policy.
Dr. Michael Heise
Dr. Rolf Schneider
David F. Milleker
Claudia Broyer