Most important macro-drivers towards policy decisions

There is always a temptation to look at only one element in deciding on the monetary policy decisions. For example, the rates should be kept low to boost industries and from this perspective a central bank would have never raised rates. However there are multiple objectives that a central bank strives to accomplish using its monetary policy and hence there are multiple macro drivers that a global central bank looks at. The following are some of the key ones:

a. Inflation

Inflation is the primary concern of a central bank. It would always strive to keep inflation low so that the cost of goods and services does not exceed the normal growth rate of income. A higher inflation is disastrous to the economy and its participants. However a deflation, reduction in prices over time is also detrimental to the economy as it affects the consumption cycle as well as industry demands. People tend to consume less in deflationary environment and hence businesses tend to get affected. Hence a central bank tends to ensure that the inflation remains low but positive by hiking rates whenever there is a fear of higher inflation.

b. Unemployment

Unemployment is a major global worry these days as unemployment leads to lower demand, social unrest as well as poor outlook. Hence a central bank tends to ensure that the policy is such that it reduces unemployment which is either by driving demand and GDP or by reducing interest rates to ensure that corporations hire more and expand businesses. This is contrary to the policy of reducing inflation. Hence a central bank would need to maintain this balance.

c. Growth

A central bank though doesn't generally have growth on its mandate, it generally strives for it. Generally, it would strive to achieve higher growth as it helps reduce unemployment and also ensures a general positive outlook for various participants. Also, it ensures that businesses do well and hence there is smooth production and performance of the economy. A central bank generally reduces interest rates to promote growth.

d. Bubble formations

This has been a recent addition to the drivers that a central bank looks at. Considering the 2008 crisis, this driver is being looked at very closely to ensure that there are no major bubbles formed as a burst of this bubble would lead to serious repercussions for the economy. A bubble burst would cause economies to lose several years of growth. A central bank monitors this closely and ensures that there is prudent risk taking thus avoiding bubbles. Higher risk taking due to lower interest rates is generally curbed by the central banks by ensuring that they keep interest rate expectations under control.

Global Melt down on the cards

There are numerous articles being published about how the world economy is coming out of recession and that there is going to be growth and development. I believe, that the contrary is true. That there is a possibility that the world economy is going to crumble and this could be one of the most severe economic crisis, the world has ever seen. The following are the main reasons which I believe can take the global businesses and economy into a downward spiral.

a. China Hard Landing
With China, the world's second largest economy facing a slow down in growth, there is a clear evidence of reduction in demand of all goods and services right from commodities to electronics. The shrinking market size would not only lead to lesser profitability and greater default rates but would also dent the global growth numbers severely. Besides, China has an over leveraged equity and housing market both of which are facing serious downward pressure. Also, many mining and commodity companies are staring at huge losses as China's demand has gone down. At 6% growth rate of China, the world is fretting. If its growth reduces below 3-4%, it could lead to severe hiccups in global economy. China is facing its most severe economic pressure in the past few decades.

b. Euro Zone sovereign crisis
With Greece still not being able to pull out of recession and the famous PIIGS still in trouble, Euro zone is one of the most serious threats to global economy. Italy and Spain have ever increasing unemployment rates. Also, these countries are too big for even Germany or ECB to consider bailing out. If Italy fails, it can set shock waves not just to ECB and euro zone but the whole world. ECB's QE has hardly had any impact in improving the GDP or consumer confidence or unemployment. Any shock in them and ECB might just run out of measures to shore up their growth. Greece is still burning cash and there is little improvement in its fiscal situation.

c. Oil Shock
Oil is the most under estimated of the shocks for the global economy. Not just oil price fall help the consumers but it also destroys the producers. Right from major oil companies which are still one of the biggest industries in the world to the oil producing nations, all are facing pressures. Oil single handedly drives the highest percentage of global trade. There are hosts of industries which are heavily dependent on oil price and a fall in it could lead to their complete collapse. Most of the biggest oil companies in US and the world are AAA rated and banks have severe exposures to them. A fall in oil prices make their business unviable and continued pressures on oil prices could lead to domino effect from these companies to banks to overall global business. Also, oil producing countries are facing unprecedented loss in revenues and are finding it hard to balance their budgets. If one of the major countries defaults, it could lead to ripple effects across the world.

d. Global Banking industry
The global banking industry is in a state of uncertainty due to multiple reasons. Firstly, most banks globally have huge derivative exposures which are vastly dangerous and carry a huge risk. Some of the banks have such huge exposures that if not corrected on time, they can bring the whole bank down. Besides, increased regulation have made their business unprofitable. Combining this with litigation charges, most of the major banks in the world have posted losses this quarter. Banks are aggressively down sizing and it seems that some of the banks might not see the turn of this decade due to their over leveraged balance sheets and unprofitable business strategies.

e. United States of America
With US going into elections, there is a huge amount of policy uncertainty. This could lead to severe confidence crisis in an already worried global macro-economic scenario. Also, the rate hike cycle of Fed could very well dry up the liquidity and make the cost of doing business more expensive across all companies. This can have serious repercussions.

Overall, I feel there is severe downside risk for global growth and there is a possibility of the most major economic setback of the century being just around the corner.