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Ahead of Wall Street

Wednesday, September 5, 2012

Monetary policy could serve as a powerful tool to stimulate economic growth. It works by easing financial conditions through improved liquidity and reduced interest rates. The markets are looking for central bank leadership in the current environment of a synchronized worldwide slowdown. The Chinese economy is slowing down, the Euro-zone seems to have slipped into a recession, and the outlook for the U.S. economy remains sub-par. The profit warning from FedEx (FDX - Analyst Report) is the latest manifestation of this worldwide phenomenon.

But the effectiveness of fresh monetary easing is unlikely to be the same in each region. Interest rates and bank reserve requirements have plenty of room to fall in China. The European Central Bank could cut short-term interest rate as well, but the more effective measure that they could do is to ease conditions for the fiscally weak nations by purchasing their bonds. Expectations are growing that the ECB will come out with a bond-purchase program at its meeting tomorrow. Disagreements remains within the Euro-zone policy elites about the optimal course of action. But a bond purchase program could go some way towards easing pressure on the beleaguered Spanish and Italian governments.

The U.S. Fed is also expected to come out with a fresh bond-purchase program, the third for the Fed, at its meeting next week. But monetary policy may not have as much traction in the U.S. case as it is expected to have in the cases of China and the Euro-zone. In this speech at Jackson Hole, Bernanke attributed a fair amount of economic growth to the totality of unconventional monetary measures implemented in the last three years. But with financial conditions already quite favorable, a fresh round of bond purchases may not have much relevance.

Sheraz Mian
Director of Research

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