In an interview with CNBC-TV18‘s Latha Venkatesh, Standford professor John Taylor spoke about the prospects of the global economy going into the next year, including risks it faces from quantitative easing policies followed by the US, Europe and Japan.
The inventor of the ‘Taylor Rule’, said to be generally followed by leading central banks the world over, is worried that that Federal Reserve may have gone out too far ahead on a limb with its monetary policy in order to stimulate the United States economy.
In an interview with CNBC-TV18’s Latha Venkatesh, Standford professor John Taylor spoke about the prospects of the global economy going into the next year, including risks it faces from quantitative easing policies followed by the US, Europe and Japan.
The ‘Taylor rule’ stipulates by how much central banks should raise interest rates in response to a rise in inflation or economic output.
Below is the transcript of the interview on CNBC-TV18.
Q: Let me start first with the good news. The latest US GDP number of 5 percent indicates a fairly robust recovery. Do you think the Fed will hike rates exactly after the promised two meetings of no action?
A: Yes I think it is. It is about time that we move back to a more normal monetary policy because the interest rate has been zero since the crisis. We have had a lot of unconventional policies as well. So, yes it is about time.
In many respects the recovery so far has been disappointing. It is slowest recovery we have had from a similar kind of crises. However now that it is pretty clear that we are effectively at a normal time again, it is appropriate for the Fed to begin to make the moves and I think they will.
Q: In that case do you worry that the Fed will be concerned that inflation is not at its target of 2 percent. In fact falling commodity prices may push the inflation index even lower. Will that stay the Fed's hand?
A: The inflation rate is just a bit below the 2 percent target. Again based on what has worked for monetary policy in the past with an inflation rate over 1 percent, with the economy getting close to normal all historical precedent would be that you would have a positive interest rate even by now quite frankly. So, that is what the Fed is aware of. They don’t want to get behind the curve.
With respect to the oil prices, it is a dramatic fall and that will affect the inflation rate but these are more temporary effects. Monetary policy makers around the world recognise that. So, ultimately the concern is with the longer term rate of inflation. If they begin to react too much to the short term effects it begins to have negative impact on the economy.
Q: You have long argued against quantitative easing but now Europe looks set to go down that path early next year. Some buying of even government bonds looks imminent over there. Do you think they should go down that path at all?
A: To give some perspective to this, the quantitative easing in the US has not worked. If you go back and look at this recovery – [it was] very slow. The first attempt to unwind it last year caused lot of turbulence in the US and the global economy. The more recent one has been better because it has been more strategic. Overall this has really not helped as far as people who have looked at it carefully can tell.
However what it has done is affected currency markets. You first saw the reaction to that in Japan with their quantitative easing and to some extent you see in the reaction in Europe with theirs. These attempts to move to quantitative easing has made the dollar stronger. I think that has been their motive. Ultimately if you went back in history and thought of all the quantitative easing around the world we would have been better off without it. However we are there now and Europe is in a situation where they have to deal with the situation as it stands.
Q: Do you see and European economic recovery by the end of 2015?
A: All of this depends on the policy. One of the things I have been emphasizing since before the crisis is that when we get off track on policy, things don’t work so well. You can see that looking at different countries at different periods in time. US for example had an amazing strong economy in the 80s and 90s, we got off track and we had this crisis and slow recovery. Hopefully we will be back on track.
Europe's problems go back a little further as their unemployment rate has been so high, it is distressing. So, to say that they are going to recover in less than a year is very optimistic. However I think the idea of change in the policy is now again focusing on these issues which will give stronger growth, longer time it will help employment and that is what they should be doing.
Q: Japan too is all set to embark on another wave of quantitative easing (QE) with the return of Shinzo Abe after the elections. Even here do you see quantitative easing resulting in a recovery in Japan?
A: Once again the quantitative easing in Japan began more recently with Abe as he appointed Kuroda to run the Bank of Japan. I think that is best seen as a response to quantitative easing elsewhere in the world because the yen got very high. With this new action the yen has depreciated and that is thought to be important for the recovery in Japan.
However the other part of this new policy, they call it the third arrow and that brings me back to my main concern here is there has not been much progress on the longer term things that the Japanese economy needs to do. So, you do see effects of QE, I think larger in exchange markets. You are not seeing much effect elsewhere yet. There is lots of turbulence with the tax increase. The main impact now they are going to postpone this tax increase and that is probably good thing to do in Japan, that will be a positive.
Q: With dollar being the world’s currency US bonds are bought by all countries with dollar reserves – China, Russia, Japan, India, in a sense US can have a looser monetary and fiscal policy than other countries. Is that the defining advantage in the US and help QE succeed?
A: It is an advantage. There is more demand but that can flip back again. You have to recognize there may be a time where people say we are not going to buy so many treasuries and we need to be aware of that.
What can actually appear to be advantage can be a disadvantage if we become complacent and we say don’t worry we can just sell our bonds to the rest of the world and then suddenly they change. In addition that has to be paid back, interest has to be paid back. So, in general it is a false view that it is an advantage.
Ultimately you have got to think about this globally as well to the extent that countries borrow or lend too much in other currencies and as exchange rates move it can be risky. We are seeing a little bit of that now with respect to the movements of the dollar. Some countries have said we are now going to have to pay back these dollars and that is going to cause them some problems. It could come back and feedback on the whole world economy.
Q: A key trend this year has been the huge rise in the US dollar especially vis-à-vis the euro and the yen. Even [Fed vice chair] Stanley Fischer sometime back worried about the dollar strength and said it might postpone the Fed’s rate hike decision. Do you think further dollar strength can stymie US recovery?
A: I don t think so. There are countervailing forces here. US economy does have some momentum. I would not focus on the dollar strength at this point as a negative. To me the more serious negatives are just basic kind of policies. Is monetary policy going to be too delayed, is regulatory policy going to continue to intervene more than it should. Those are the concerns that I have.
I think at this point the strength of the dollar, the relative weakness of the euro and the yen during the period you mentioned is undoing or is reversing something that occurred in the other direction where the yen was very strong and the euro was very strong. So you need to put this in a longer term perspective. I don’t think it is going to be a negative to the US economy in the near term.
Q: Do you see dollar rising even more in 2015 given the weakness in the euro and yen and their economies? Will strong dollar be one key feature of 2015?
A: I think you have already seen it. Markets don’t just look at the past they look at the future and they have been seeing the Fed ending its quantitative easing at least the purchases of additional securities, increasing the balance sheet, they have seen that diminishing and simultaneously they have seen Japan and Europe go in the other direction or in the case of Europe at least talking about it. So, that affects their expectations and affects the currency. So, the movements that you have already seen in the currency reflect those changes in policies.
Q: How do you see Chinese growth in 2015, recently an economic advisor to the People's Bank of China (PBOC) said that Chinese growth would dip to maybe 7.1 percent in 2015 from the 7.3 percent that was last reported for 2014? Do you think China will even deliver this?
A: China is also going through some reforms in their economy. I think those reforms are quite beneficial. They are trying to deal with some of the corruption issues, they are trying to deal with some of the freedom issues and frequently with economic reforms is a transition period where people get used to it, economy gets used to it and that could be a slowing as you see now. China has been more integrated in the world economy simultaneously so I think there is no reason why China can’t continue to grow. They can’t grow at super high rates forever but it can bounce back and it will.
Q: China is also one of the big engines for the commodity markets, so, what is your take on commodities in 2015? Do they get weaker or do they stabilise and recover?
A: I think there has been such an adjustment already that the markets are searching for a new level if you like. I think the actions here of the oil producers are very important. There is a lot of debate about how long they will let this go down or they can let it go down? We have seen a big change in commodity prices; I don’t think I will expect to see much more along those lines.
Here I would say there is also the sense of what kind of stability we are going to see on the policy side. I think this point if you see some more stability you will see a greater stability with respect to commodity prices I don’t see major changes going forward.
Q: I don’t know how much of an interest you take in Indian issues, what is happening here is that the central bank governor Raghuram Rajan has been trying to put a framework based on your Taylor principle. Thanks to his upping interest rates and with some concerted fiscal discipline India’s five year old double digit inflation has come down to sub 5 percent but Governor Rajan isn’t cutting rates yet. He is under pressure from the government which is worrying about poor growth. Now what is the right point to let up on rates? Do you think a 2 percent real rate of return is what Governor Rajan should aim at? Is he right to insist on inflation to the exclusion of growth?
A: What we have seen in history again if I could just appeal to what I know about world and different countries, most important thing with respect to growth is to get that inflation rate to a more reasonable level. So, he saw as you say double digit inflation, he knows the recipe to deal with that. It’s not controversial really and is taken the action and fortunately as you say the inflation rate has come down. So, that I think is a measure of success. They need to continue that kind of a policy. However ultimately what we have seen is that kind of action is what is going to enable the economy to grow more rapidly, it is going to be a positive.
The analogy of the US, we had a high inflation in the late 70s. Paul Volcker was appointed to chair the Fed, he took action which focused on getting inflation down and it resulted in a very successful economy; higher growth, lower on employment in the decades following. So, I applaud the idea of getting that inflation rate down and focusing on that and I think it has been successful so far. I don’t see anything to complain about.
Q: Both the central bank and the government are soon going to possibly agree on a monetary policy framework and an inflation target. Do you think that will ensure central bank independence and allow it to pursue its low inflation target?
A: I think central bank independence has been healthy and important with a picture for inflation goals. I would applaud that move. It is also very hard to know just based on the law and based on other things how much independence central bank actually has. However, I think the notion of being explicit by an inflation target at some point when the time is right that is a good idea but then in addition to that managing monetary policy in a way that is consistent with that inflation target, I think if you get a look around the world, countries that have moved towards some inflation target of some kind and have implemented a policy to do that is been quite successful and I would applaud if they do that.
Q: Do you see defaults by commodity countries like Nigeria, Venezuela or even some Russian banks as one of the destabilizers of financial markets in 2015?
A: These are big effects on the countries and they have had other effects too particularly Russia. Russia is right now playing a pretty weak hand. People sometimes forget that changes in prices, oil prices or whatever if you are a buyer you like low prices, if you are a seller you don’t like low prices. So, there is if you like adjustment that occurs and it can be quite damaging. With respect to the debt what is most important now is that we work on any agreement internationally to deal with that in a way that avoids the kind of bailouts that we have seen in the past. I don’t see in any of these cases a problem yet in that respect but what I have observed is that if we move to say the IMF or other international organisations having a bailout philosophy, that is damaging. I don’t see that happening but I would be careful about that and in the mean time these countries will have to make the adjustment which is not going to be easy.
Q: What may disrupt financial markets in 2015? Could it be a Euro zone country wanting to exit or wanting to default? Could it come from China? What should the world beware of in 2015?
A: You would want to worry about these big changes in the order that you have just raised, there is a possibility. People would react too much too it and that could spill over.
Right now the biggest risk is there being an overreaction on the policy side to some of these changes and that can create a snowball. In a way it is more risky now because there are so many different kinds of policies that are being followed. It can be unconventional monetary policy, unusual policy with respect to QE and even fiscal policy has varied for many countries and there is debate. So, with respect to policy we are not in such a steady period. Not every country is the same, there are a lot of differences.
However that situation, sometimes it is called policy uncertainty. Uncertainty about policy if that brings about reactions that spirals then that is a risk. If the policy is conducted in a steady way, here if the US gets back to a more conventional policy in a gradually strategic way that will remove a lot of that uncertainty and to me will remove a lot of the risks as well. After that I would say I really think at this point people are saying when are we going to make the more fundamental structural changes in Japan and Europe and the US? At some point they are going to say they are not doing it and then we are going to have the risk of really slow growth long term and that will be a realisation which will not be good.The Great Diwali Discount!
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