Central banks, especially in industrialised nations, are reaching the limits of their policy tools, with little to show for what they have done so far.
At the height of the global credit and sovereign debt crises, central banks in the U.S. and the eurozone played superhero and rushed to the rescue by slashing interest rates to near zero and implementing asset purchases (referred to as ‘quantitative easing’) to pump funds into their wheezing economies. While these monetary stimulus measures have, prevented economies from outright flat-lining, they have, so far, had a mild effect on growth.
The U.S. economy grew by 2.8% in the three months ending September, which was the fastest pace in over a year. However, the gains in the quarter have a large one-off component; stripped of that gain, growth came in at a much lower 2%. News from across the pond isn’t much better: the eurozone limped out of six straight quarters of declining output to post a 0.3% expansion in GDP in the second quarter (April-June). Making matters worse, these seeming recoveries have not been accompanied by job growth. Unemployment remains at a high 7.2% in the U.S. while it hit a record high of 12.2% in the eurozone, judging by the most recent data.
In theory, lower interest rates should stimulate demand, both investment and consumption, and thereby increase economic activity. However, many financial institutions, already saddled with either bad government or mortgage-related debts, have been reluctant to lend further for fear of further exacerbating their bad loans. Meanwhile, consumers are also reluctant to spend as jobs growth remains poor and uncertainty about future economic prospects persists.
So despite substantial amounts of money sloshing about in the financial system, Europe, in particular, seems to be struggling with the threat of deflation (falling prices). That’s exactly the opposite of what critics of monetary stimulus feared when the money spigots were opened; they predicted the world would face a frightening bout of hyperinflation. That hasn’t happened in five years. Neverthless, most of the money has ended up in stock markets and housing markets, building up the same problems that plagued the global economy before the credit crisis erupted in 2008.
The real economy of the U.S./Europe have seen little beneficial effect. And that’s going to be a big problem going ahead. Given that interest rates are at record lows on both sides of the Atlantic, central banks can do little to further stimulate economies. Five years into the crisis, and despite quick actions by the Federal Reserve and European Central Bank, what we have are low economic growth, even lower inflation, lagging job creation and growing worries of asset bubbles.
Arguably, central banks took the lead in taking co-ordinated action to prevent economic catastrophe in the wake of the credit crisis. That was both a good and bad thing. Good because we needed someone to take action, and bad because by taking action, monetary authorities allowed their fiscal counterparts (governments) to dial back the need to implement structural reform and other policy measures required to ensure that such crises can be better handled in future. For instance, the U.S. government hasn’t passed one full budget after the global credit crisis started, while European leaders have dithered (and bickered) about undertaking structural reforms to make the eurozone stronger and resilient in the face of another economic crisis.
In the end, there is only so much monetary policy can do. If we have another crisis (and one does come along with persistent regularity), the role of superhero will become increasingly difficult for central banks to play. Who’s going to save us then? Yikes.