The Economics Nobel award this year to Ben Bernanke (former US Fed chief), Douglas Diamond and Philip Dybvig is not exactly non-controversial. There is a marked irony here: they have been awarded for their 1983 theoretical work that formed the basis for quantitative easing policies followed by the Fed in the aftermath of the Great Financial Crisis. This comes at precisely a time when large swathes of the globe today are actually battling the ill-effects of that flood of easy money and its imminent roll-back. It was precisely two decades back, in November 2002, when Bernanke as Fed Governor apologised on behalf of the Fed for its having been instrumental in deepening the Great Recession of the 1930s -- by hiking rates at that time and creating a liquidity crisis. Banks bit the dust, as a result. Questions are now being asked on whether a similar apology for QE, where the Fed adopted a diametrically opposite course of action, is in order.

The hypothesis of the awardees is that it is not the collapse of aggregate demand alone that triggered the recession of the 1930s and 2007. The collapse of the banking system played a bigger role in deepening and prolonging the recession, they say. Therefore, they argue, it is important that large financial institutions are kept alive through liquidity infusions in order to contain a financial contagion. In a September 2018 paper for Brookings, Bernanke argues: “the severity of the (2007) recession cannot be explained by a deterioration in housing and consumer finances alone, but in large part reflected the widespread run on short-term funding and securitised credit”. He concedes that US unemployment levels in 2009 exceeded Fed estimates, as the crisis’ impact was underestimated. In the present context of tightening, the laureates argue that banks must keep more liquidity buffers than at present to deal with shocks, and to that extent the post-GFC regulations are in order.

This is all very well, as far as managing the US economy is concerned. Bernanke et al showed us a way to revive an economy when interest rates are at rock bottom. In fact, the Fed’s playbook on throwing liquidity lifelines to key financial market actors whenever crisis strikes has been adopted by other central banks during the Covid crisis too, India included. But then one cannot ignore the unintended consequences of free and cheap liquidity infusions into financial markets by way of asset price bubbles and persistent inflation. It is QE and its withdrawal that have forced emerging economies to deal with the unpredictable ebb and flow of global capital, compromising their monetary policies and putting their currencies at jeopardy. At the heart of interest rate setting is a dilemma that needs to be cracked: how to arrive at a rate that is high enough to dissuade asset speculation and yet not choke off growth. The spillover of Fed rate actions on the markets and economies all over the world deserves more attention – an issue that India has flagged over the years.