QE Lite: A Gateway Drug

Asad Dossani
Suppose an individual starts smoking marijuana or drinking alcohol. According to the gateway drug theory, the use of less dangerous substances can lead to the use of more dangerous substances in the future.

At some point, this individual wants a larger buzz. Maybe he starts using cocaine. And then perhaps he turns to heroin or methamphetamine.

In this context, marijuana and alcohol are gateway drugs. On their own, they may not be too harmful. The danger comes from what they can lead do.

Earlier this week, the RBI announced an asset purchase program to bring down interest rates. Our colleague Vivek Kaul dubbed the action QE Lite. In spirit, it is similar to what the largest central banks have doing for a long time. Buying bonds and injecting cash into the financial system.

When a financial market gets used to a central bank supplying liquidity, they typically demand more. The central bank, terrified of markets, naturally decides to supply more.

This is exactly what happened to the US Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of Japan (BOJ). For example, the Fed began asset purchases in late 2008, just after the peak of the financial crisis. It took a full six years to stop. And even now, they've yet sell off these assets.

The ECB began asset purchases in 2009, while the BOJ joined the party in 2010. Both are still at the party, and there's no end in sight.

And now, the RBI is knocking at the door. Maybe they're just testing the waters. Perhaps they won't stay for too long. In fact, they'll probably go home after one drink.

Or not. Is it possible that QE lite is simply a gateway drug? One that leads to full blown QE? Will markets eventually depend on the RBI to step in anytime there are frictions?

There was a time when interest rates were set by the markets. The demand for and supply of funds were what mattered. If there was a funding gap (i.e. excess demand), interest rates would rise. The gap would be no more.

Today, we live in a world where interest rates are set by a central bank. If the central bank thinks interest rates are too high, it supplies funds and liquidity to the market.

The logic for central banks, rather than the markets, to set interest rates is beyond me. There are times when central banks should supply liquidity. If there is a panic, crisis, or a run on banks, the central banks should step in. They should fulfill their role as the lender of last resort.

But outside of these panic moments, what's the logic for central banks artificially lowering interest rates?

Prominent economists have claimed that QE has been fantastic. Its not a gateway drug. Its a wonder drug. But I'm not convinced.

It turns out that the evidence on the gateway drug theory is mixed. Yes, sometimes drinking and smoking leads to the abuse of dangerous drugs. But more often that not, it doesn't. I know plenty of individuals who smoke or drink, but have not used dangerous drugs.

Will QE lite be a gateway drug for the RBI? Let us know in the Club or share your comments here.

Before I sign off, I'd like to inform you that my colleague, Apurva Sheth, has reopened membership of his exclusive trading service, Swing Trader. It doesn't matter if you are novice or seasoned trader, Apurva can guide you in these volatile markets and show you how to trade profitably. You can try out this service for 30 days.

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4 Responses to "QE Lite: A Gateway Drug"
08 Apr, 2016
I do not think that RBI monetary policy is like QE as adopted by developed economies on the mass scale and for such long period. Ours is a developing economy with lot of human and natural resources are being untapped, demanding required funds and capital for showing their potential. As far as RBI is concerned it has to closely monitor the productive use of QE funds released through its recent declared policy. Otherwise any diversion of funds for unproductive purpose and for speculative use will lead to more disaster as reserves wilh RBI and its monetary tools so effective are limited. Thanks Like 
indusekhar das
08 Apr, 2016
I am absolutely one with Assad. Smart and intelligent looks do not always carry a smart and intelligent person. All that glitters is not gold. When this latest givernor to RBI was placed I thought here is the most awaited Jesus to carry India into prosperity. But the measures he has introduced, like this fund injection, or, making ATMs almost defunct are certainly not pro-prosperity. Thank you Assad for being bold....keep this show up....Like 
Chandravadan Ajmera
08 Apr, 2016
My Dear Asad; It is a wonderful idea to have market determined interest rate. RBI will be just a watch dog like LIC just observing the market and entering as and when needed. I think the financial experts like you should draw attention of Mr Modi by writing him. This man has a courage to think out of box.Like 
Chandravadan Ajmera
08 Apr, 2016
Market determined interest rate is just a wonderful idea. RBI should be just a watch dog keeping the market under watch and entering the market when there is panic or very abnormal scenario. jus like LIC who enters the market when needed. I think the people like you who are financial experts should draw the attention of Mr Modi for his perusal. This man can do anything you think provided he is satisfied.Like 
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