Six
and a half years after the global financial crisis, central banks in
emerging and developed economies alike are continuing to pursue
unprecedentedly activist – and unpredictable – monetary policy. How much
road remains in this extraordinary journey?
In
the last month alone, Australia, India, Mexico, and others have cut
interest rates. China has reduced reserve requirements on banks. Denmark
has taken its official deposit rate into negative territory.
Even the most stability-obsessed countries have made unexpected moves. Beyond cutting interest rates, Switzerland suddenly
abandoned its policy
of partly pegging the franc’s value to that of the euro. A few days
later, Singapore unexpectedly altered its exchange-rate regime, too.
More
consequential, the European Central Bank has committed to a large and
relatively open-ended program of large-scale asset purchases. The ECB
acted despite a growing chorus of warnings that monetary stimulus is not
sufficient to promote durable growth, and that it encourages excessive
risk-taking in financial markets, which could ultimately threaten
economic stability and prosperity (as it did in 2008).
Even
the US Federal Reserve, which is presiding over an economy that is
performing far better than its developed-world counterparts,
has reiterated the need for “patience”
when it comes to raising interest rates. This stance will be difficult
to maintain, if continued robust job creation is accompanied by
much-needed wage growth.
This
new round of central-bank activism reflects persistent concerns about
economic growth. Despite a once-unthinkable amount of monetary stimulus,
global output remains well below potential, with the potential itself
at risk of being suppressed.
Making
matters worse, weak demand and debt overhangs are fueling concerns
about deflation in the eurozone and Japan. Anticipating falling prices,
households could postpone their consumption decisions, and companies
could defer investment, pushing the economy into a downward spiral from
which it would be very difficult to escape.
If
weak demand and high debt were the only factors in play, the latest
round of monetary stimulus would be analytically straightforward. But
they are not. Key barriers to economic growth remain largely unaddressed
– and central banks cannot tackle them alone.
For
starters, central banks cannot deliver the structural components – for
example, infrastructure investments, better-functioning labor markets,
and pro-growth budget reforms – needed to drive robust and sustained
recovery. Nor can they resolve the aggregate-demand imbalance – that is,
the disparity between the ability and the willingness of households,
companies, and governments to spend. And they cannot eliminate pockets
of excessive indebtedness that inhibit new investment and growth.
It
is little wonder, then, that monetary-policy instruments have become
increasingly unreliable in generating economic growth, steady inflation,
and financial stability. Central banks have been forced onto a policy
path that is far from ideal – not least because they increasingly risk
inciting some of the zero-sum elements of an undeclared currency war.
With the notable exception of the Fed, central banks fear the impact of
an appreciating currency on domestic companies’ competitiveness too much
not to intervene; indeed, an increasing number of them are working
actively to weaken their currencies.
The
“divergence” of economic performance and monetary policy
among three of the world’s most systemically important economies – the
eurozone, Japan, and the United States – has added another layer of
confusion for the rest of the world, with particularly significant
implications for small, open economies. Indeed, the surprising actions
taken by Singapore and Switzerland were a direct response to this
divergence, as was Denmark’s decision to halt all sales of government
securities, in order to push interest rates lower and counter upward
pressure on the krone.
Of
course, not all currencies can depreciate against one another at the
same time. But the current wave of efforts, despite being far from
optimal, can persist for a while, so long as at least two conditions are
met....
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