The Ultra-Easy Money Experiment

Looking at the pre-2007 world, there was ample evidence to warrant such theoretical concerns. While globalization was holding down inflation, the real side of the world economy was exhibiting many unusual trends. Household saving rates in the English-speaking economies fell to unprecedented levels. Within Europe, credit flows to peripheral countries led to unprecedented housing booms in several countries. In China, fixed capital investment rose to an astonishing 40% of GDP.

Moreover, similar unusual trends characterized the financial side of the economy. A new shadow banking system evolved, with highly pro-cyclical characteristics, and lending standards plummeted even as financial leverage and asset prices rose to extremely high levels.

The monetary policies pursued by central banks since 2007 have essentially been more of the same. They have been directed toward increasing aggregate demand without any serious concern for the unintended longer-term consequences.

But it is increasingly clear that ultra-easy monetary policy is impeding the necessary process of deleveraging, threatening the independence of central banks, raising asset prices (especially for bonds) to unsustainable levels, and encouraging governments to resist making needed policy changes. To their credit, leading central bankers have stated repeatedly that their policies are only buying time for governments to do the right thing. What is not clear is whether anyone is listening.

One important impediment to policy reform, on the part of both governments and central banks, is analytical. The mainstream models used by academics and policymakers differ in important respects but are depressingly similar in others. They emphasize short-term demand flows and presume a structurally stable world in which probabilities can be assigned to future outcomes – thus almost entirely ignoring uncertainty, stock accumulations, and the financial imbalances that characterize the real world.

Recalling John Maynard Keynes’s dictum that the world is ruled by little else but the ideas of economists and political philosophers, perhaps policymakers need new ideas. If so, the immediate prognosis for the global economy is not good. The latest fashion in policy advice is essentially still more of the same.

The call for outright monetary financing involves raising government deficits still further and financing them through a permanent increase in base money issued by central banks. Targeting the level of nominal GDP (or the unemployment rate, as in the United States) is a way of convincing financial markets and potential spenders that policy rates will remain very low for a very long time. All of these policies run the risk of higher inflation and/or still more dangerous economic imbalances.

Sadly, a fundamental mainstream reassessment of how the economy works is by no means imminent. It should be.

William White, a former deputy governor of the Bank of Canada, and a former head of the Monetary and Economic Department of the Bank for International Settlements, is Chairman of the Economic and Development Review Committee at the OECD. The views expressed here are his own.

Copyright: Project Syndicate, 2013.

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