Evidence Indicates That Monetary Policy Works

The UK and Australia were the countries that most aggressively relaxed their monetary policy in response to a perceived serious recession. These are also the countries that show the earliest recovery from the recession, showing clearly that monetary policy is still very effective in reinvigorating a frail economy.

In the first quarter, Australia recorded 0.4% growth, led by the strongest export performance in 48 years. This is after a 0.6% decline in the last quarter of 2008. The renewed strength of the economy has taken the Australian dollar to well in excess of 0.8 cents, well above the 0.64 or thereabout just a few months ago.

This experience clearly shows the absurdity of some East Asian countries that tried to bolster a depreciating currency by sharply raising interest rates. Australia had aggressively pushed its main interest rate down by 425 basis points in seven months.

The weak Australian dollar in part on account of this major decline in interest rates helped push exports, which rose 2.7% in the quarter, while the sharp interest rate declines lent support to domestic consumption and the labour market, offsetting the weakness in business investment.

The Bank of England also aggressively reduced its interest rates six times between October and March, bringing them to 0.5%, and launched major fiscal stimulus, both of which led to a very weak pound which at the low point exchanged only for less than US$1.4.

Although the UK economy is still mired in recession, there are early signs of recovery, indicated by a PMI for services above the reading of 51.7 in May, and a PMI reading for manufacturing at 45, both of which are well ahead of those of most other OECD countries.

House prices rose by 2.6% in May after three months of successive falls, according to figures released by the UK's largest lender. The construction PMI also rose sharply, to 45.9 in May from April's 38.1.

Comments

[Dave Wrixon:]

Absolutely, unless you are perceived as being insolvent as a Nation, then a whole new raft of issues come to the fore, and lax monetary policy only exaccerbates deep seated problems.

Jun 09 07:36 AM

[market ace:]

You can think that monetary policy has some bearing on the recovery of these countries, but it cannot really ever cure economic problems. It just shifts the bubbles around in a boom or oust manner and distorts the proper allocation of capital. Autralia is a majoir commodity exporter and as such stands the best chance for an early recovery regardless of interest rates or currency values. On the other hand the UK is toast and may never recover. Their ridiculous montization policy and piles of debt (just like the US) will leave them deep in recession for a long time even with interest rates at zero.

Jun 09 10:37 AM

[Larrysyr:]

The "proper allocation of capital" is largely in the eyes of the beholder. If I were truly rich, for instance, I would think the proper allocation of my capital would be in a monopoly, where I could earn out-sized returns from high prices. Being not rich, I think a more proper allocation of capital is in companies competing to give me the best products/services at the lowest prices.

Jun 09 12:51 PM

[Living4Divi...:]

Of course monetary policy works, the side effects of too much stimulation are inflation and currency devaluation.

Jun 09 05:55 PM