When we look at the IMF’s global liquidity indicators, the total reserves of central banks, excluding gold, exceeded 12.3 trillion dollars. Again, according to IMF reports, the total liquidity supply provided to the markets exceeded the level of 18.5 trillion dollars. In particular, the Fed stated that its asset purchase through bond purchases during the pandemic was open-ended, and the European Central Bank announced that it had extended the program, which it announced as 750 billion euros in March, by 600 billion euros, until June 2021.
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These expansionary policies and incentive practices had 3 main objectives:
1) Ensuring financial stability
2) Maintaining the quality and level of household life
3) Preventing companies from being crushed under their financial debts
What tools were used to achieve these 3 main goals:
1) Low interest rate policies implemented by central banks
2) Injecting liquidity into the markets through loans through banks
3) Employment protective packages
4) Postponement of loan installments
5) Cash grant incentives for the low income group
6) Measures and incentive packages for the revival of trade
7) Regulatory changes in loans and other financial instruments
8) Applications to increase total demand
9) Measures to encourage production
Among these tools used, the first implementation and the most prominent compared to the others were the interest reduction actions by the central banks. Central banks of other developed and developing countries accompanied these global practices, which started under the leadership of the Fed. Subsequently, a series of measures were taken to ensure that the quality of life of households does not deteriorate and that companies experience difficulties under their financial debts.
At the moment, we have begun to see that the introduction of new expansionary monetary policy steps or the direction of the markets with the interest rate instrument are not very effective in the current agenda.
In fact, the technical term for this situation in economics: liquidity trap. Liquidity trap refers to the situation in which monetary policy loses its effectiveness in an economy. As a result of expansionary monetary policies, the policy interest rate, which fell to very low levels, even to zero or below, cannot trigger a demand-side recovery in the economy, and households and even businesses tend to save rather than spend. Investments cease and savings fall under the pillow rather than interest-bearing assets, or turn to safe metals as an interest-bearing alternative. When we look at the current situation, we see that as a result of these expansionary monetary and fiscal policies, interest rates have dropped to very low levels, yield rates have decreased, and the demand has been converted to ounces, which is a safe haven. As a result, we watched that ounce gold prices broke records several times in 2020. There are still expectations for new records to be set until the end of the year.
In order to express in a simple way, without going into statistical data, that all these expansionary measures taken began to lose their effect, it would be sufficient to remember the last 2 meetings of the Fed and the policy interest rates meetings of other developed country central banks.
What are they?
In the last meetings of the central banks of America, Europe, England, Japan, China, there was no expectation for the market to change interest rates. As a matter of fact, it was so and the central banks did not change their interest rates. The most highly anticipated topics were the headlines that the central bank presidents would give in their press releases after the meetings. Although it was eagerly awaited, we did not hear anything newsworthy from any central bank governor meeting. Moreover, when we looked at the markets after these meetings, we saw that there were no serious turbulences. In other words, we can say that the markets did not see the monetary policy meetings of the central banks as a newsworthy agenda.
Let’s come to the long-awaited famous question: What will happen next?
Let’s analyze what will happen next, by dividing them into short-term and long-term predictions.
The low interest rates as a result of expansionary monetary policies and the decrease in credit costs did not encourage companies to make new investments in the unpredictable and unpredictable environment we live in under the fears of the second wave. A rebound in demand was seen as a rebound from the bottom, and improvements were seen in retail sales data on a monthly basis. In other words, the delay in demand has started to be put in place somehow. As such, we cannot say that a complete liquidity trap has occurred. However, if an increase in global inflation begins and the general level of prices increases, the expected employment level cannot be achieved and people cannot return to their jobs, then a liquidity trap may come to the fore.
So what if a liquidity trap occurs? What is the risk?
When the liquidity trap occurs, the low interest policy applied loses its effect. The monetary policies of the central banks become ordinary and have no effect on the market. Households prefer savings over consumption, and they do this for assets that are considered safe-haven rather than risky assets. The delay of households in their consumption preferences brings the risk of stagnation in aggregate demand, and there is a possibility of disruptions in the business cycle in the face of this situation. The worst thing is that the general level of prices, namely inflation, does not enter into a decreasing trend while such a situation is experienced in the economy.
If we look at the long-term, it is relatively difficult to make a prediction here. In terms of timing, it is difficult to predict what the long term is. The reason is that the news of the Kovid-19 epidemic still continues. In particular, Fed Chairman Powell’s statement that the current interest rate policy will continue as long as there are no indications that the Kovid-19 epidemic has completely disappeared, and the European Central Bank’s announcement that the economy emergency aid package will remain in effect until June 2021 requires us to make a slightly longer-term forecast. . When we put these long-term projections on the table, it shows that a time will come when world economies will struggle with possible serious public deficits.
As for why we think that it will face such a problem, we can bring up the possible decrease in tax revenues, which is at the top of the income elements of the states. In addition, when we think that such high liquidity in circulation will create inflationary pressures, this liquidity will have to be withdrawn from the system in some way.
How will this be done?
With the issuance of treasury bills and government bonds, this liquidity will be withdrawn. This means government borrowing. This will be a relatively difficult part of the job, because on the one hand, it is not easy to manage the debt burden that will arise, while increasing the welfare level of the citizens, which is the main duty of the state. It seems that successful state administrations in the coming years will be those who take the right steps in this difficult process and follow a delicately balanced policy.
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