Economies and markets have improved, thanks to central banks

Growth in the major developed economies accelerated in the first quarter of 2013. With stock markets around the world also rallying strongly recently, it looks like the aggressive monetary policies of major central banks have been successful.

Among the major developed economies, the United States, Japan and the United Kingdom reported growth in the first quarter. The euro area was the laggard, contracting in the first quarter for the sixth consecutive quarter.

Nevertheless, all the major developed economies saw better economic growth in the first quarter than in the previous quarter.

Growth rates in advanced economies
	Percentage change in real GDP
	2012			2013
	Q2	Q3	Q4	Q1
United States	0.3	0.8	0.1	0.6
Euro area	-0.2	-0.1	-0.6	-0.2
Japan	-0.2	-0.9	0.3	0.9
United Kingdom	-0.4	0.9	-0.3	0.3

Surveys of purchasing managers in April indicated that global growth may have slowed at the beginning of the second quarter (see “Stock markets maintain rally even as global growth slows”).

Nevertheless, investors appear sanguine, with stock markets continuing to rally last week. The Standard & Poor’s 500 Index rose 2.1 percent last week to close at yet another record high of 1,667.47. The STOXX Europe 600 Index rose 1.2 percent last week to 308.72, its fourth consecutive weekly gain. The Nikkei 225 stock average jumped 3.6 percent to close at 15,138.12.

If stock markets lead the economy, as most economists think, then the outlook for the major developed economies is good.

The economic performance of the major developed economies as well as the apparent confidence of investors provides some vindication of the aggressive monetary stimulus, including quantitative easing, implemented by the central banks of the US, euro area, Japan and the UK over the past few years.

Indeed, last week, the International Monetary Fund released a paper that looked at the effects of the unconventional monetary policies in the US, euro area, Japan and the UK. While the paper noted that there is considerable uncertainty about the size of the impact of these policies, it nevertheless concluded that they helped to “avoid acute risks” to financial markets, “significantly reduced long-term yields” and “significantly improved macroeconomic conditions”, with both GDP growth and inflation reacting “positively and substantially” to bond purchases.

However, the paper also said that there are some “key issues that central banks engaged in unconventional measures need to consider”.

One issue is that the measures will face diminishing effectiveness.

Another is the possibility of greater risk taking by financial institutions as a result of accommodative monetary policies and the expectation of central bank intervention, which could undermine financial stability.

Also, capital flows to other countries could increase and create the potential for future abrupt reversals.

Finally, eventual exit from exceptionally easy monetary conditions may prove “challenging”.

With their much-larger balance sheets now filled with assets with longer-dated maturities, central banks could face significant losses on their assets when the time comes for them to tighten monetary policies. This would in turn impact fiscal balances through reduced profit transfers to government.

Also, as central banks have little experience in tightening under such monetary conditions, there is a risk of interest rate volatility and overshooting during the tightening process.

However, for now, most of the advanced economies and stock markets appear to be enjoying the fruits of central banks' bold monetary policies.