Loose Monetary Policy is worsening Wealth Inequality

Context: The report by Independent Evaluation Office (IEO) of International Monetary Fund (IMF) has emphasised on the significance of Capital Flows Management (CFM) measures amidst global economic crisis.

Arguments for restricted capital flows:

• Feature of Bretton Woods Agreement: that currencies would be convertible on the current account but countries were free to use capital control measures to dampen currency speculation.

• Impossible Trinity: which states that only two of three specific policies—a stable exchange rate, an autonomous monetary policy and an open capital are possible at a given time.
• Impossible Duality: which says that regardless of exchange rate regime, capital flows make it impossible to have autonomous monetary policy.

Arguments for liberated capital flows:

• Rising dollar liquidity: 

• Rise in the United States’ (US’s) fiscal deficit from 4.6% in 2017 to 18.7% in 2020 and 6.5% in 2021 as per IMF.

• Low bond yield has detracted open-ended borrowing leading to a situation where Federal Reserve end up as both the market maker and sole market participant in government bond.

• Impact on central banks of emerging economies:  Carry trade (Dollar borrowing seeking higher return in emerging markets) is going to rise, creating imbalances and side-line central banks.

• Carry trade even though preferred by investors, corporate borrowers and sovereign in developing world, it causes disruptions in domestic credit aggregates and investments.
• A Push from the IMF: The IEO report prods the Fund to accept the need for even a pre-emptive and longer-lasting application of CFM measures in certain situations 
• CFM measures could be useful in dealing with social issues such as housing affordability. 
• Capital account liberalization has played a big part in financializing many asset markets, including for housing. 
• Financialization also plays a role in fomenting social discontent and polarization.

Conclusion: The Fund believes that capital account liberalization in the long-term is desirable and to be exercised depending on the context.