Proud home of the European Central Bank.

Proud home of the European Central Bank. Photo – AlphaTangoBravo/Adam Baker

There seems to be a lull over the global economy. The recent comments by European Central Bank President Mario Draghi have again provided support to the equity and commodity markets. Added to this, the expected announcement from the Fed also seems to be creating a new rally in oil and gold with both commodities reaching highs of $90/barrel and $1623/oz. There seems to be a short term outlook that both markets have on the future which is causing such volatile movements. Investors are going along with the announcements that are coming and are forecasting future prices between dates rather than setting their sights on a long term target or date. They, however, cannot be blamed.

There is confusion on the part of policy makers and a plethora of information is being churned out daily. In order to quell the uncertainty of the system, the politicians and ministers are doing everything they can to address market concerns when they should be building a consensus on a unified policy for the future. The next few weeks are going to be very interesting in this regard as every country tries to do rectify the situation with the best of their ability within their own borders. One complexity that is overriding the domestic economies is the looming eurozone crisis which has further limited options available for the European countries to be able to use all the resources available at its disposal.

Chancellor George Osborne has been under pressure from all around after his austerity measures attracted criticism from all spheres. There are fears that a double dip recession is looming and so it is the responsibility of the government to increase spending to kick start investment into the economy. This means that with limited resources at hand, the government has been forced to back down on a debt reduction strategy and has to do more now seeing that UK’s economy actually contracted in the last few months.

One solution that has been suggested by the British Chamber of Commerce is to borrow surplus from the private sector at low rates available right now and to invest it in public projects. This would compliment other programmes already put in place where BoE has expanded its quantitative easing programmes to £375bn ($543.22bn). Experts believe that the program might be expanded to £500bn ($787.28bn) by end of the year and that rates would be cut to 0.25% to throw the kitchen sink at this problem. The main focus is to create a long term goal that the policy makers can work towards and they can even be able to cultivate an environment where businesses are stimulated both directly and indirectly leading to long term economic growth. It seems that the belt tightening being carried in UK can be put on hold and borrowing and deficit budgeting can be carried out in order to lead to economic growth. Or at least avoid a double dip recession.

The Atlas of the World Economy

One of the basic findings of the last decade has shown that regardless of the crisis impacting Europe or US, Brazil, Russia, India, China and South Africa (BRICS) have been able to sustain or maintain some sort of economic momentum over this period of time. Especially China and now India who have shown resilience matched by no other. However, now the crisis is taking its toll where the economic data from both these countries has been dismal and a change in trend to what it was experiencing before this. In addition to this, future growth rates have also been cut down by IMF for the BRICs as there is fear of worse times to come for the once rapid growing emerging economies.

Urgency is seen in all these countries as central banks are doing everything they can to revive the system or to at least turn the curve upwards for the future. Emerging markets have made huge gains in the last two decades and this crisis will not only threaten the short term but also long term growth prospects. When the crisis struck, the BRICS countries showed better than average growth and are still churning out GDP growth figures which exceed any other. There is still skepticism regarding them though as a sharp decline is expected thanks to the economic slowdown.

The solution to this problem lies in the ability of the central banks to respond and how flexible their course of action is. The emerging markets have an independence to use interest rates to stimulate economy as they are still around 6% on average in these countries. Another factor is the low budget deficit to GDP ratio in these countries which will allow them to borrow more. This borrowing can be sustained by the economies for a longer period of time as well.

The Japanese response

The case for Japan seems to be more of the same old story. Last month saw more bond purchasing being carried out by the central bank. On Wednesday, Bank of Japan Deputy Governor Hirohide Yamaguchi said further loosening of the monetary policy might be required if the economy’s response is slow. There are certain challenges to BOJ’s forecasts contingent primarily on the European debt problem and slowing down of the economy. A trend that is developing around the world is the use of unconventional assets for purchase by the central bank in order to maximise the impact of the monetary policy rather than just government securities. Similarly, Japan is also looking towards foreign bonds in order to stimulate the economy. There is also focus towards a fiscal solution to the problem where government borrowing is expected to be carried out while staying within the bounds dictated by international norms and not to get carried away.

The recent eurozone crisis has shown that policy makers are now looking towards announcements, data releases and short term solutions in order to quell the market sentiment and to try to build investor confidence in the markets. The focus has turned towards short term easing of the system and long term stability and growth have taken a back seat. The recent rhetoric of the central banks shows that there is a need for pressure easing in both the short and long term realm of markets. The concerning fact still remains that the trial and error method of long term policies might just prove to be one of the many as crisis prolongs.