Quantitative easing and economic lessons from the past

By Lee Myong-hwal

Since the global financial crisis, the world economy has seen unprecedented revamping and experiments taking place around the globe. Major economies have turned to unconventional policies represented by quantitative easing, marking a drastic paradigm shift in monetary policy. In the past, these moves would have been seen as highly abnormal and even undesirable, but they are growing more familiar by day.

These recent developments are reminiscent of the early days of the Great Depression when major countries struggled with the gold standard. In the 1920s, the post-WWI period, major economies restored the gold standard which was temporarily suspended during the war. Politicians, scholars and government officials touted the gold standard as an impeccable system. They never got over their blind belief in the gold standard, and never doubted that its usefulness might dwindle in time, or that it might have side effects.

The consequences of such negligence were dreadful. At the time, Britain and many other countries with overvalued currencies faced a trouble of weakening export competitiveness, economic slowdown and deterioration of the banking industry. Under these circumstances, they would have done well to cut interest rates and adopt an expansionary monetary policy.

But unfortunately, they raised the interest rate to safeguard the gold standard. Their rationale for monetary tightening was to maintain gold convertibility and stabilize exchange rates, but it rather deepened recession and accelerated capital outflows. To stabilize exchange rates, major economies had to further raise interest rates, which in retrospect, was the most foolish monetary policy decision that precipitated the worst crisis ever.

The countries should have immediately broken away from the golden fetters to sever the pernicious link between a tight monetary policy, deflation and economic recession. However, at the time, it did not occur to them. They were trapped in the past. The ensuing Great Depression finally opened people’s eyes to the fallacy of the gold standard. Subsequently, countries abandoned the once-sacred gold standard and finished a race for currency depreciation. Only then could they slowly begin to escape from the Great Depression.

The latest paradigm of monetary policy is based on the bitter lessons from the time of the Great Depression. Recognizing the need for new policies, the Fed put aside the old dogma, and launched quantitative easing in a swift and bold manner. It was an effort to prevent another episode of the Great Depression. Some criticized that the measures were opposite to the rigorous tightening that was employed in many other past crises. However, the Fed marched on unperturbed. Only time will be able to tell whether the Fed’s decision was right. So far, however, the tactic seems to be smooth-sailing buoyed by the solid credibility of the Fed, with a capable leader, Ben Bernanke, at the helm.

Now Japan is following the suit of the U.S. Its aggressive quantitative easing under “Abenomics” is also based on its past experiences during the Great Depression. The current move is akin to ‘Takahashinomics’, which lifted Japan from the pit of a depression through aggressive monetary and fiscal policies. Nonetheless, the global financial market is watching Japan’s moves warily.

It is partly because the current fiscal condition is different from the time of the Great Depression. But more fundamentally it is because Japanese government and the Bank of Japan had lost their credibility over time. In fact, Japan was the first country to implement a quantitative easing policy, and repeatedly used the measure during the so-called lost two decades. Unfortunately, Japan was neither prompt, nor bold or consistent in implementing a set of policies, which undermined market confidence in ‘Abenomics’.

Turning the focus to Korea, the BOK has been through rough times lately because its ill-timed hesitance and inconsistency impaired its credibility. At the critical juncture of the paradigm shift and the changing economic surroundings, many eyes are on the next move of the BOK to see how it will make changes from the old and strengthen its status.