In recent past, unconventional methods adopted by Central Banks of two major economies of the world- Japan and China brought to the limelight a new face of monetary policy. The "negative interest rate policy of Japan" and "currency devaluation by China" were meant to mitigate the phase of prevailing economic stagnation. Lets have a bird's eye view of these policies.
Negative interest rate policy: The interest rate in an economy is decided by Central Bank. It varies from time to time based on the needs of economy. For example, in India, RBI has been entrusted with the responsibility of deciding interest rate or commonly known as repo rate through its bi-monthly monetary policy review. Repo rate implies the interest rate at which commercial banks borrow from RBI to meet their liquidity requirements. It is an important monetary tool used by central banks to control lending activities by commercial banks and regulate inflation. Conventionally, this rate is positive which is quite obvious, since borrowers must pay certain interest to creditors. So far all good. Imagine a situation when the interest rate is negative!! What does that mean?? Well, it simply means that borrowers get paid by creditors as an incentive to borrow further and depositors are deprived of interest they have been paid so far on savings account, instead they have to pay for their deposits. Cheaper credits and expensive deposits!!!
Japanese economy was grappling with sluggish growth rate due to poor demand of goods, low inflation rate, rampant unemployment which compelled Bank of Japan to take such course of action. The idea was to channelise the repositories of wealth which had been amassed by public in savings bank account towards healthy investments thus, triggering economic growth. More investment means enhanced production of goods leading to greater demands for labour implying more employment. More employment implies more wages leading to more demand of goods giving rise to inflation and further boosting industrial production. And ,the cycle continues.
Here, two points must be reckoned, first, inflation is not always bad for an economy. It has a brighter side also. Its presence reflects that an economy is flourishing and not lying dormant or stagnant. And, second that sometimes below zero interest rate can lead to "bank run" due to dearth of liquidity.
Although, the central bank explored new strategy to counter the ineffectiveness of conventional measures, not everything worked as anticipated. Initially, the situation showed some signs of abatement but present manifestations portray a grim picture.
Devaluation of currency:Liberalisation, which has transformed this world into a global village, is a precursor to unprecedented growth of international trade.Organisations such as WTO, formerly known as GATT have further glorified it by encouraging free and fair trade. Foreign trade involves import or export of goods in exchange of currencies. In order to bring homogeneity in the system, dollar has been chosen as standard currency. Imported goods are paid in dollars. Dollar is bought from the Central Bank in exchange of local currency (yuan/ renminbi, considering the case of China). The price of dollar is determined by dollar-yuan exchange rate. The exchange rate is inturn, regulated by market forces of demand and supply or the so called invisible hand as proposed by Adam Smith- Father of Economics. In case of rise in imports, demand for dollars increases. As demand increases, more yuan is required to buy a dollar. In other words, dollar becomes expensive, its value increases or to be precise it "appreciates". Simultaneously, yuan "depreciates". This makes imports expensive but boosts exports!! How?? The goods in foreign markets become cheap as one dollar can now buy more quantity of goods.Thus, exports bring in more dollars and forex reserves of the country show a healthy trend. This emulates the trade deficit and current account deficit of a country.
Well, the People's Bank of China deliberately interfered with the exchange rate and "devalued" yuan with respect to dollar. As explained above, devaluation was done in order to boost export of Chinese goods in the international markets. However, cases may arise when exports get squeezed under poor demand of goods in the international arena. In short run, things might appear rosy but in the long run, expensive imports can lead to "forex crisis" thus, sabotaging the economy.
Central bank is regarded as the pillar of economy shouldered with twin responsibilities of maintaining economic robustness and dissipating crisis. Its prompt and cognitive actions prevent economic evanescence thus imparting global competitiveness and exuberance to the economy. In the above two cases, the interplay of multiple factors culminated in futility of the policies but at the same time added a new dimension to the geopolitical canvas of South-east Asia!!
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