There is no such a thing as a free lunch

Monetary policy restrict

IO – There has been much discussions about the surge of gold prices; bullion shot up as high as USD 2000 per ounce. In a recent op-ed in Kompas I conjectured that out of different explanations of why this happened I think the one that stands better to reason is assessing its role as a basis of currency exchange system. The recent surge of gold bullion prices could be interpreted as evidence of the weakening of the US dollar as an “anchor” to the global financial system. 

It is to be noticed that the last time the price of gold bullion surged was after the Fed, later followed by the Bank of England (BOE), European Central Bank (ECB) and the Bank of Japan (BOJ), implemented an extremely loose monetary policy, reverting to what became known as “quantitative easing” (QE), later to be known as a “new monetary policy”. 

The policy was initially introduced in combination or in support of extraordinary fiscal stimulus, as a response to the global financial crisis of 2008/09. The main feature was the purchase by the Fed of sovereign, financial institutions, and corporates debt that had been monetized via securitization to become financial securities. A similar policy had been implemented by the BOE, the ECB, and the BOJ in their respective economies. For BOJ, it was apparently not the first time this central bank implemented it. According to a National Bureau of Economic Research study, BOJ was in fact the first one to resort to QE, in 2001, to address the deflation problem that Japan faced at that time (NBER Working Paper No. 27339). 

The policy was a new one then, employing unconventional instruments introduced to support a fiscal stimulus to address devastating shocks to the economy. It successfully saved the world from falling into a depression of the 1930s type. Nevertheless there was global recession and/or anemic growth from 2007 to 2009. During this period global GDP declined by 5.1%, with unemployment rate reaching more than 10%. But the severity and duration differ, in different countries. This period came to be known as “The Great Recession”. I think Professor Milton Friedman would remind us from his grave about his dictum that there is no such a thing as a free lunch. 

In the meantime, even before many economies returned to their pre-GFC condition, the world economy started suffering from another blow, which many confirm to be more devastating than the GFC, with a shock that is world -wide, i.e. the Covid 19 pandemic. 

To fight against its devastating adverse economic impacts, it is not just the developed economies resorting to a huge fiscal stimulus; in fact, emerging economies do likewise. Thus, this time, both developed as well as emerging economies have decided to conjure up a similar combination of policies, an extraordinary fiscal stimulus with the support of modern monetary policy, relying on quantitative easings or the like. The NBER study cited above analysed the events of QE policy implementations by 21 countries, 8 developed and 13 emerging, including Indonesia. The study was conducted by Jonathan S. Hartley Alessandro Rebucci. 

It may still be too early to say whether the world will suffer similar anemic growth or a Great Recession, as with post-GFC. There have been different studies, including ones by the World Bank and the IMF, that predict negative growth of economies in many countries, including that of Indonesia, either for the second quarter or for 2020. I am not joining the debate of predicting whether our economy will be in recession or not here. In fact, doing so would be a bit futile at this point, I think. 

This paper will discuss the issues related to the policies combating the pandemic with a view to how emerging economies as new players, in the combination of fiscal and monetary policies, which seem to be based on an attitude of “whatever it takes” as former ECB President Mario Draghi was known to say in defending bank policy that later became known as new monetary policy, in the effort to fight against the global financial crisis and its aftermath. 

What is Unconventional Monetary Policy? 

The term “unconventional monetary policy”, also known as new or modern monetary policy, is conducted by a central bank or monetary authority of any country, and comprises monetary steps taken by this institution when the usual techniques or instruments could no longer be effectively used to achieve its objective(s), either monetary stability or monetary stability plus economic growth. Conventionally, this refers to the instruments a central bank normally uses – rates of interest and open market operation, i.e. purchasing and selling treasury notes and foreign exchange market intervention. Maybe also tinkering with prudential measures, like tightening or relaxing the capital adequacy ratio of banks. 

When the economy suffers very low or even zero rates of interest, then changing them is no longer effective: interest rates no longer work as a means of resource allocation. Economists talk about the liquidity trap case in economic analysis. During the global financial crisis and its aftermath, when economies were weak, interest rates were already very low or even zero for a long time, so the Fed could not rely on interest rate policy to push banks to extend credit and revive aggregate demand. Instead, under Chairman Bernanke, the Fed introduced a new step in its effort to push bank loans and demand, by purchasing securities held by banks, financial institutions and corporations. In different versions, the securities include medium or even long-term ones, like sovereign bonds with 10-year maturity or even longer, like mortgage backed securities (MBSs). The new instruments include those with medium and long maturity while conventional monetary instruments are exclusively short-term. 

The Fed did that in its effort to support the policy of stimulating aggregate demand which was very weak, due to the crisis. The government stepped in, conducting a fiscal stimulus. Since the fiscal space was weak as shown from high debt to GDP ratio (high leveraging) and sizeable budget deficit, then the monetary policy was called in to provide liquidity via purchasing securities that included those issued or owned by the government (MOF) itself and corporations. This is the popular criticism against the government for “deficit financing by printing money”. In any case, development economists used to discuss about how many less-developed economies could not collect enough tax revenues in their budget and would thus resort to what it was called deficit financing of development. I commented on this unconventional monetary policy in 2013, by naming it ‘monetary-cum fiscal policy’ (“Central Bank Independence at the Crossroad?”, RSIS Commentaries, No 129/2013). 

For sure, post-GFC and during the Great Recession we did not observe any case of adverse impact of this policy (as was usually the case with many developing economies in the past, i.e. high rates of inflation, let alone hyperinflation, that ensued). In fact, in many years of the recent past most countries no longer talk about inflation at all. In other words there has not been any problem of inflation, except may be the case of Zimbabwe toward end of President Mugabe’s reign with a bewildering rate of 231 million % in 2008. My own experience: at one point I changed the syllabus of one of the courses I taught, Economic Analysis for International Political Economy – which professors must do every now and then to keep our lectures up to date – was changing the section discussing inflation to deflation. 

Conceptually, as explained by John Mouldin in “Velocity Trap” (Thoughts from the Frontline, Oct 20, 2014) what happened was that the money multiplier, i.e. how many times the money was used for making payments per unit time – annually, quarterly etc – was low and declining over time. The total additional liquidity which reflects the additional value of purchasing power to buy goods and services is the summation of the additional money in circulation multiplied by the money multiplier. In other words, the additional liquidity had not been spent to purchase goods and services and thus the additional liquidity did not push prices up. As a result, no inflation occurred. 

Another way of interpreting why these increases in liquidity had not been causing inflation may be due to the condition that the fund flows have been confined to among and between banks and financial institutions as well as corporations. They were not yet in public hands; thus, they have not pushed aggregate demand to press aggregate supply and thus did not result in inflation. 

However, the additional liquidity from this money creation must have some implications that could become problematical later. When the Fed exercised the new monetary policy via making purchases of securities from banks, financial institutions, even corporations as well as sovereign bonds in extraordinary amount following the global financial crisis, its balance sheets started to balloon like crazy. Likewise, the balance sheets of other central banks followed the same steps. Similarly, in the face of the recent pandemic, these central banks also resorted to making huge purchases of securities in support of fiscal stimulus, which the fiscal authorities in these economies provided in their fight against the devastating economic impacts of the pandemic. 

At the aftermath of the GFC and during the Great Depression the additional liquidity resulting from Fed’s quantitative easings was more than USD 3.5T. In the meantime, the additional liquidity resulting from similar policy conducted by central banks of the UK (Bank of England), EU (ECB) and Japan (BOJ) also added another USD 3 T to 4T in a few years, since 2008/2009. But the increase of liquidity facing Covid-19 is even more spectacular. According to Dr. Andrew Sheng, former central banker and financial regulator of Malaysia and Hong Kong, the Fed added liquidity of USD 3T in a couple of months, while Europe, Japan and China added a cumulative USD 6T during the same period. This balloons total assets in these central banks’ balance sheets to a breath-taking USD 25.2T, amounting to 28.7 per cent of last year’s global GDP. (“Central banks’ coronavirus bailouts are distorting the market, but do they even realize it?” in South China Morning Post, 01/08/2020) 

Yes, the steps taken by these central banks must have mitigated the adverse impacts of the pandemic on the world economy. However, the huge additional liquidity is like a cloud overhang that one day could open up with a downpour and resultant flood. People must remember the “taper tantrum” of 2013. Chairman Bernanke only mentioned that due to economic recovery the Fed might impose a policy of reducing the holdings of securities or tapering off the program of purchasing securities, but this acted as a shock on the market. The emerging economies were frightened of capital withdrawals returning to the US and other developed economies. This time, a similar phenomenon will come to pass; it is only a matter of when. 

As mentioned above, facing the Coronavirus pandemic goaded emerging economies, including that of Indonesia, to resort to this technique of quantitative easing. A similar issue of additional liquidity one day will need to be resolved: it is no different. For the emerging economies, the challenge may be larger, due to more limited space, both in fiscal as well as in monetary spheres. The new monetary policy has certainly been a new and promising means, but for sure there is a limit as well. The new monetary policy will make the monetary authority better-equipped in burden-sharing with the fiscal authority. It could certainly support fiscal authority, but not substitute for it. 

For emerging economies like that of Indonesia, the day of reckoning will not only refer to the ability to repay debt outstanding when the bonds are due to be retired. As bonds are basically financial securities that are traded in the capital market, even before their due dates the holders may want to sell off their holdings whenever they feel they want to. Debt management starts the time securities ownership shifts to buyers. It has been understood that approximately 40 % of Indonesian bonds are held by foreigners. 

There is still one more aspect that I need to mention here. It is the distribution aspect of the adverse implications of the pandemic, which many seem to overlook. Statistics show that the victims of the Coronavirus in terms of those having positive and the number of deaths everywhere have been uneven, in that the poor suffer more in every country. As if this is not enough, the unfortunate fact has been that the policy to cope with the pandemic has also been exacerbating the suffering of poor groups. Whether total or semi lockdown with social distancing, mask and washing requirements or others had burdened relatively the poor more than others, since basically they are less equipped to living under these stringent requirements imposed by a new normal. 


This is a complicated issue to deal with, let alone explain clearly. I would like at this juncture just to make some points that hopefully lay out what we are facing clearly, to find means for mitigating the adverse impacts. I concur, just like I agree that modern monetary policy has been working in the recent past as experienced by some developed economies in response to the GFC and the Great Recession. But, even in this case, policy has raised issues that must be resolved, i.e. how to normalize the central banks’ balance sheets without creating financial shocks – nor, God forbid, another crisis. 

Now, at this time we cannot even be sure about when this pandemic will leave us; yet many economies have been resorting to the new monetary policy. Of course, the same issue about the day of reckoning (like the previous one) is there waiting to be resolved. But this time the challenge is even bigger, since recent policy facing the pandemic has been more dramatic than before. And more importantly, this time emerging economies, including our own, have been resorting to the new monetary policy with similar features as before. There have been records with the notes I mentioned before, but for sure these economies survived worse situations while still maintaining their stability. 

It would be a remiss not to mention the last point. The new monetary policy that Bank Indonesia resorted to is a commendable policy to support the extraordinary fiscal burden and confront the adverse effects of the pandemic on our economy. It is unfortunate that the fiscal space has not been strong (to say the least). For sure, aiming at improving fiscal space by raising the tax ratio is currently not realistic. The short- and medium-term challenges are daunting for sure. We will see whether we will be all right. We certainly hope so.