Monetary policy is not a magic wand and excessive money supply does not necessarily promote growth. Instead it can cause high inflation or put the economy into a recession and liquidity trap when demand is weak, writes Assoc. Prof. Dr. Nguyen Huu Huan from the University of Economics Ho Chi Minh City.
In recent days, some banks have reduced their lending interest rates to 0%, something that has never happened before in Vietnam, to encourage people and businesses to borrow money.
The move aims to resolve excess mobilized capital that has not yet been lent and to reach their credit growth targets. According to surveys, banks are encouraging businesses to borrow now even if they have no immediate need for the capital.
These interest-free loans in Vietnam are a phenomenon, aiming simply to stimulate credit demand in the short term, but this is also an issue that needs attention.
Offering an interest rate of zero is not unheard of globally because throughout history other countries have found themselves in similar situations.
For example, during the 2007-2009 financial crisis, the U.S. economy fell into recession and forced the U.S. Federal Reserve (Fed) to continuously reduce interest rates to stimulate growth. However, this policy failed due to weak demand, and while interest rates hit 0% unemployment remained high and the economy showed no signs of recovery.
0% is considered the fatal threshold of monetary policy, because nominal interest rates can only reach 0% and cannot go negative, except for special cases in some European countries where interest rates have dropped to negative 0.25% in the past (Negative deposit interest rates mean depositors have to pay more deposit fees to banks, while negative lending interest rates mean lenders have to pay more money to borrowers). These situations are unlikely to happen in reality because if so, people would rather keep money (cash preference theory) than deposit or lend it at negative interest rates.
Another case is Japan. When its interest rates were close to 0%, monetary policy seemed paralyzed. Late Japanese Prime Minister Abe Shinzo introduced his economic theory (often called Abenomics) with loose money and helicopter money policies, but this did not help Japan escape deflation and the liquidity trap.
The U.S. was luckier than Japan when it escaped the 0% level thanks to long-term quantitative easing packages, which affected not only short-term but also long-term interest rates for businesses and people. This helped confidence return, people became bolder in spending, demand recovered and output increased, accompanied by a decrease in the unemployment rate.
For Vietnam today, the fact that nominal interest rates could go to 0% poses a danger to the economy as we may be caught in a liquidity trap. When consumer and credit demand is weak, increasing the money supply will not have any effect. But as a result, interest rates will approach 0% and at that time, further loosening of monetary policy will not have much meaning.
In my opinion, this is no surprise because if loose monetary policies are maintained for too long, the economy won't be able to absorb the excess and interest rates will drop to 0%. However, I estimate that thanks to the expected Fed interest rate reduction, global and Vietnamese demand will recover well, thereby increasing credit demand, and Vietnam will not fall into the same situation as the U.S., Europe or Japan. The reason is that Vietnam still has much room for growth like other emerging countries, but not like large economies facing growth problems.
However, Vietnam should avoid following in their footsteps and instead operate monetary policy according to the principle of neutrality, meaning the money supply is just enough to meet the needs of the economy. If the economy cannot absorb all the money that's made available, we should withdraw it. We should pump and withdraw money flexibly in line with market signals. Don't let short-term growth goals affect long-term stability and growth.
Not every increase in money supply means economic growth, because the neutrality of monetary policy in the long term as well as real variables of the economy such as output and unemployment do not depend on nominal money supply in the long run. Increasing the money supply only has a short-term economic stimulation effect when it affects the demand for goods and services, thereby affecting short-term output, but overusing the money supply can also cause high inflation, or put the economy into a recession and liquidity trap when demand is weak and the money cannot be absorbed.
If increasing the money supply could lead to strong long-term economic growth, all countries would be rich. Monetary policy is not a magic wand, and no matter what policy the central bank pursues, output and unemployment will always stay at their natural levels in the long run.
Vietnam’s credit as of December 13 had increased 9.87% compared to the end of last year, but was still some way off the 2023 target of 14%, reported the State Bank of Vietnam (SBV).
Of the total, credit to the agriculture-forestry-fisheries sector expanded 3.17%; industry and construction 7.31%; trade, transport and telecommunications activities 11.94%; and other service activities 5.3%.