Economists on both sides of the ocean have pondered over the Global cool down of the world economy. Central banks all over the world are increasingly pursuing expansive monetary policies to address concerns over financial meltdown. What’s surprising is these policies of easy credit, lax lending standards and destabilization of the monetary base are what caused the financial crisis of 2008 and the subsequent Global meltdown of the world economy. This crisis was engineered by polity pursuing central banks to achieve growth through monetary policy rather than fiscal and structural changes.



The result is we have a financial system where Central Banks have expanding balance sheets as they continue to monetize Public and private debt. The low interest rates (negative real rates) are wiping off individual investments and incentivizing people to take on more credit and save less. Despite of all this, the Businesses worldwide are not investing in productive assets and instead borrowing for share repurchases, causing further asset bubbles. The DJIA has climbed to prerecession levels since July 2012 without any significant increases to underlying firm’s earnings.



The average US household, with damaged balance sheet, is deleveraging and will continue to do so. The private sector debt has only come down from 100% of GDP to about 87%. The QE3 is supposed to help the housing sector by decreasing the Mortgage rates for consumers and putting downward pressure on the housing prices. However the transfer of lower rates to consumers is not working because banks are reluctant to lend due to credit risks and high paperwork backlogs. On announcement of QE3 the yields on MBS fell by an average 30 basis points but the average 30 year fixed rate for mortgages did not change. The current spread between MBS yields and 30 Year fixed rate mortgage is at 1.5%. The financial intermediaries are pocketing the 30 basis point increase in spread. So even if Mr. Ben Bernanke wants his QE3 ($40bn a month MBS buyback) to stabilize the housing market, it is only sustaining the asset bubble at the cost of expanding FED balance sheet.



QE3 in normal times would have buoyed exports as it pushed the dollar down and US stock prices up. However I doubt that this will budge the US current account deficit by much as global demand remains weak.



From the demonstrated failure of monetary policy alone as a cure for this malice, it is quite understandable why Professor Roubini presents a strong argument for fiscal policy actions and structural reforms from the Polity. However just looking at the polity and the fractured mandate from the Electorate across both sides of the Atlantic, it does not appear that the cure is in order any time soon. So the prospect of a lost decade looms.

