QE2's end may lower inflationary pressure

Updated: 2011-06-09 11:17

By Zhong Nan and Ariel Tung (China Daily)

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QE2's end may lower inflationary pressure

US Federal Reserve Chairman Ben Bernanke speaking recently at Georgetown University in Washington. Bernanke sent out a strong signal on Tuesday that the Fed is not planning to change its monetary policy despite weaker economic data. [Photo/Agencies]

US economic recovery proceeding 'at moderate pace', says Bernanke

BEIJING / NEW YORK - As the second round of quantitative easing is about to end in the United States, economists say China's inflationary pressures will be eased.

To boost the US economy and employment rate, the Federal Reserve launched a massive $600 billion Treasury bond purchase program, known as QE2, in November.

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But this policy has sparked excessive liquidity concerns around the world, especially in emerging economies.

The Chairman of the US Federal Reserve, Ben Bernanke, sent out a strong signal on Tuesday that the Fed is not planning to change its monetary policy despite weaker economic data, saying that the recovery "appears to be proceeding at a moderate pace".

"The US economy is recovering from both the worst financial crisis and the most severe housing bust since the Great Depression, and it faces additional headwinds ranging from the effects of the Japanese disaster to global pressures in commodity markets," he said in a speech in Atlanta on Tuesday. "In this context, monetary policy cannot be a panacea."

Experts said this is good news for China.

"Commodity prices in China will be stabilized and capital may flow back to the US if the Fed starts to tighten its monetary policy, which will be very helpful in relieving China's imported inflation," said Lai Pingyao, a professor of economics at the University of International Business and Economics in Beijing.

Soaring prices have already become a cumbersome issue for China. The consumer price index, a main gauge of inflation, reached 5.3 percent year-on-year in April, only 0.1 percentage point lower than the 32-month high seen in March, according to the National Bureau of Statistics.

"The inflow of US 'hot money' will be gradually weakened by the termination of QE2," Lai said.

"Hot money" refers to the flow of funds or capital that moves very quickly from one country to another. The influx usually generates short-term profits on interest rate differences and anticipated exchange rate shifts, potentially leading to market instability.

Lai also said that with the end of QE2, the dollar is expected to rebound and rising commodity prices in China will be curbed.

"If the US begins to pursue a tighter monetary policy, the increased value of the dollar will make it easier for China to keep the renminbi low against the dollar without printing so much money," said Ethan Ligon, associate professor at the University of California, Berkeley. "Then we should see reduced inflation in China."

Since December 2008, the Fed has kept the cost of borrowing at historic lows, and this loose monetary policy has drawn criticism both at home and abroad.

The dollar has dropped by more than 11 percent against six other major currencies, making US exports cheaper but also contributing to higher prices for imported raw materials, energy and food. Countries such as China, Russia and Germany, have all expressed concern over the falling dollar.

Derek Scissors, a research fellow at the Heritage Foundation based in Washington, said China is proficient in dealing with inflationary pressure and is also fully capable of taming its inflation rate after QE2 ends.

"Chinese inflationary pressure stems first from China's own, much larger quantitative easing in 2009, in response to the financial crisis. It stems second from funds inflows. But these inflows are due to China's economic policy, where the yuan is kept rigid and the central bank buys up incoming foreign currency with domestic currency. This increases the amount of domestic currency in circulation," Scissors said.

"The countries that were affected by QE2 are all small economies. China's economy is not only the world's second-largest, its money supply is the world's largest. In comparison, QE2 is trivial in size."

In China, economic growth can be eased or adjusted by taming inflation with government policies. In the second half of 2010, the government took a series of tightening policy measures to induce downward pressure on China's inflation rate, including currency revaluation, interest rate hikes and tightening liquidity.

Pieter Bottelier, a senior adjunct professor of international economics at Johns Hopkins University in Baltimore, Maryland, said China's recent high inflation rates were not caused only by QE2.

"The inflationary pressures in China mainly resulted from the very rapid credit expansion from 2009-2010; the prolonged drought around the country, which led to an increase in food and vegetable prices; and the rise in international commodity and food prices," he said.

Bottelier believes the US economy is still facing a number of severe challenges, such as slow recovery from the financial crisis, a high unemployment rate and large fiscal debt. The objective of the QE2 policy was to reduce long-term interest rates as a way to encourage corporations to invest more. But the results are fairly limited.

Liu Wenge, a professor at the Central University of Finance and Economics in Beijing, said the end of QE2 will be the end of the Fed's accommodating monetary stance.

With slow economic growth and the US presidential election season looming, the Fed will adopt new economic policies to improve the economy, he said.

"Be they QE3 or export-stimulating policies, only time will tell," Liu said.



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