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Has Monetary Easing Really Run Its Course?

After years of unprecedentedly easy monetary policy in the world's advanced economies, many are warning that the stimulus potential is depleted, particularly in Japan, with its negative short-term interest rate. But this view fails to account for the exchange-rate mechanism by which monetary policy is transmitted to the real economy.

TOKYO – Since the 2008 global financial crisis, expansionary monetary policy has been the order of the day in most of the major advanced economies. This approach – comprising deep interest-rate cuts and large-scale asset purchases (quantitative easing, or QE) – has been credited with accelerating the recovery in the United States and the United Kingdom, and pulling the eurozone back from the brink of collapse. As for Japan – which introduced monetary easing in late 2012 as the first “arrow” of Abenomics, Prime Minister Shinzo Abe’s economic-reform program – the policy has contributed to the creation of about 2.5 million jobs.

Yet, with low interest rates implying that central banks will have little ammunition to fight the next economic downturn, has reliance on generous monetary conditions to sustain growth gone too far?

The conventional view, in line with textbook Keynesian economics, is that monetary expansion works through the interest rate: by reducing the cost of money, a lower interest rate stimulates domestic investment, spurring growth. Once the interest rate gets too close to zero, below which it usually cannot be reduced, monetary easing is no longer an effective economic stimulus. By this standard, Japan – with a short-term interest rate of -0.1% and a ten-year government-bond yield target of around 0% – would seem no longer to be benefiting from its expansionary monetary policy.