A move to quantitative easing may be the only way to prevent the global economy from falling into deflation, BCA Research suggests.

“Quantitative or credit easing, coupled with dramatic fiscal support, may be the only viable option to prevent a debt-deflation spiral from taking hold,” BCA says in a research note.

“The depth of the economic recession and widespread deflation suggests that nominal policy rates need to drop into negative territory in order to provide adequate stimulus, which is impossible,” it observes.

In equilibrium, the cost of capital should be roughly equivalent to nominal GDP growth, BCA explains. If interest rates are held above the GDP growth rate, this restricts activity and creates recessionary pressures. “Given that there will likely be a rare decline in nominal GDP in the developed world this year, there is also a need for nominal policy rates to drop into negative territory (i.e. close to zero and accompanied by aggressive quantitative or credit easing) in order to provide sufficient stimulus,” it says.

“The world economy is still at risk of falling into a debt-deflation spiral and reflation efforts will need to be ramped up further,” BCA concludes. “Policy rates are converging on zero and aggressive quantitative or credit easing measures in each of the major countries can be expected. Ultimately, this should benefit high quality spread product, but also government bonds given that central banks will buy these bonds outright or will buy private sector assets that could help push government yields lower via arbitrage.”

IE