For the past several months, every time the US Federal Reserve has been about to announce major economic figures, the financial world has started wondering what would happen next: Will the Fed retire the policy of quantitative easing (QE)? Are interest rates to rise? People have kept a close eye on every action, every word, indeed the very mood, of Fed Chair Janet Yellen.
Beyond the fact that QE is a monetary policy tool, and not decided on the whims of a single individual, being contingent instead to policy requirements at any given time, it is not like our economy depends completely upon QE. There is no need to get bogged down with the issue. We just need to maintain some emotional quotient, and to have a clear idea of what we need to do to deal with the situation.
While US monetary policy involves a hugely complex set of economic indicators, the most important of these are the unemployment rate and the inflation rate, which together form what is called the economic misery index.
Experience shows that there is often a trade-off between the employment rate and inflation. Certainly, some hold that both deserve equal weight when it comes to policy considerations. Nevertheless, it is generally the case that, in the US, the unemployment figures are allowed to be higher than the rate of inflation. For this reason, few believe that the US government will accord the unemployment rate more importance in its monetary policy.
Another factor worth considering is changes in the two indicators. If, indeed, an inverse relationship between the two is observed, the scale of the change needs to be considered. As a result, we might, in general, expect US policymakers to be willing to accept a minor adjustment in the rate of inflation in exchange for a drop in the unemployment rate.
Coming back to QE, the consensus at present is that the reason for the reduction in QE is that unemployment in the US has fallen to around 6 percent, down from double digits at the time of the financial crisis. For the moment, the need to stimulate demand through the money supply is significantly reduced, and policymakers have directed their attention back to the rate of inflation.
In May, the rate of inflation in the US increased to 2.13 percent, leading to some concern. However, the next month it fell again to 2.07 percent, offering some assurance to the Fed, as the situation did not warrant a tightening of monetary policy.
However, why was it, given the apparent inverse relationship between the two, that a fall in unemployment did not coincide with an increase in the inflation rate? That is not an easy question to answer, but we might want to look at a theory recently put forward by the Nobel prize-winning US economist Joseph Stiglitz.
He believes that the recent economic recovery in the US was more due to a resurgence in the stock market, and does not represent economic growth per se. That is, despite the increase in demand that was responsible for the fall in unemployment, there was no appreciable increase in incomes for ordinary US citizens, and the reason for this phenomenon could well be something that Stiglitz has been keen to stress in the past — the unequal allocation of income. It could also be related to the speed of hot money flows made possible by global capitalism.
Whatever the case may be, Taiwan’s economy is too vulnerable to external factors and it goes without saying that it will be affected by changes in QE in the US. That said, inflation in the US will drive an increase in consumer demand for imported goods, and this will almost certainly be reflected in a real increase in exports for this nation.
During this period, Taiwan, along with other Asian countries, has been hit by QE in the US, but exports have been up. Therefore, the real question remains one of competitiveness.
A reduction of QE in the US means that we need to return to actual production performance. The past few years have seen a falling off in private-sector investment, and public construction projects have fallen behind. This is a serious concern for sustained growth.
Since President Ma Ying-jeou (馬英九) came to power, Taiwan has gradually become more reliant on China for trade, which leaves us with a big question. If the US economy has indeed recovered, and demand for imports has increased, that is a great opportunity to create a more balanced trade framework. Is Taiwan ready for that?
Liu Ruey-hua is an economics professor at National Tsing Hua University.
Translated by Paul Cooper
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