LONDON – One of the most prominent questions concerning the global economy today is whether monetary policy is approaching the limit of its effectiveness. Inflation remains well below target in the eurozone and Japan, despite aggressive quantitative easing (QE) and negative policy interest rates, and both the euro and yen have appreciated against the US dollar since the start of the year.
The problem with the debate is that it has focused solely on the effectiveness of policies, without considering the need for prudence. The credibility and independence of monetary authorities are essential to the effectiveness of their policies. And yet some of the proposals being fielded call for central banks to stray further into uncharted territory, expanding and extending their deviation from careful balance-sheet management. This could inflict reputational damage that may be difficult to rectify, with real financial and economic consequences.
The direct impact of unconventional monetary policy is apparent and largely as expected (with the exception of the recent appreciation of the euro and yen). Liquidity in banking systems is ample, and borrowing costs have declined, even turning negative for some governments.
But the expected second-order effects – increased economic activity and inflation – have not materialized. As a result, despite the fact that headline inflation is being dragged down by low commodity prices, a near-consensus has emerged that additional easing is required.