Central banks are in denial about their latest string of failed policies in response to the financial crisis of 2008. Even in the face of mounting evidence to the contrary, the central bankers entrusted with developing and implementing monetary policy continue to peddle fiction about how well the economy is doing.
To be frank, the central banks must face reality before it's simply too late.
Clock Is Ticking
Over the last century or so since the Federal Reserve was created in 1913, policymakers have grown increasingly hubristic about the ability of central planning to generate economic growth and prosperity. This way of thinking was massively influenced by the theories of early-20th-century British economist John Maynard Keynes—more on that below.
In some sense, central banks have taken something potentially useful and destroyed the system's tolerance for it. This is analogous to overusing antibiotics to the point of rendering the medicine ineffective. The longer the real problem is ignored while a cocktail of monetary drugs are pumped into the ailing global economy, the more deeply entrenched our problems become.
Renowned economist Mohamed El-Erain points out, "Today’s growth shortfalls become harder to reclaim even as tomorrow’s growth potential is undermined. That, in turn, erodes the potency of any given policy response." In other words, on top of merely treating the symptoms and not the underlying illness, the drugs are becoming less and less effective. Time is not on the side of the central banks if they blindly continue on this path.
Running Out of Tricks
Keynes (and the successive generations of Keynesian economists his ideas begat) was a proponent of the government heavily intervening in the global marketplace. He generally erred on the side of more direct action by the government was better than no response at all. Keynes even once said in his General Theory that, essentially, burying bottles filled with bank notes only to dig them up again would be better than nothing.
The most common mechanism that central bankers use is the target interest rate. Whether through adjusting this benchmark (in the U.S., it is the federal funds rate) or indirectly moving interest rates through loosening or tightening monetary conditions, this is the biggest lever at policymakers' disposal.
With years of stagnation and few conventional options remaining, the new monetary policy du jour is negative interest rates. While the vast potential risks of negative interest-rate policy (NIRP) have been well-documented, worse still is the utter lack of matching fiscal policy.
Especially in today's debt-burdened markets, any suggestion of an expansion of government spending is understandably met with aversion and skepticism. To be sure, the unabated growth of the federal bureaucracy has been one of the worst consequences of Keynes' economic theories, which advocate for government expansion and intervention at virtually every opportunity.
However, one of the unintended results of the widespread quantitative easing (QE) programs has been that commercial banks simply held onto that extra cash rather than increasing lending (as was intended). Negative rates are an attempt to incentivize banks to loan that money and put it into circulation, but this hasn't happened yet.
Oddly enough, one possible improvement to this approach would be taking all that easy money and forcing the government to spend it on infrastructure. Commentary from Project Syndicate zeroes in on what this would look like: the government could "build houses, renew transport systems, invest in energy-saving technologies," etc.
While unnecessary government spending is undoubtedly one of our largest troubles in Washington, rebuilding our crumbling infrastructure is one worthwhile expense that is being ignored. If the Federal Reserve and other central banks continue to pursue increasingly extreme monetary policy, it ought to at least be matched by a fiscal solution.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.