Paul Lachine

The West’s Punch Bowl Monetary Policy

Choosing a short-term boost to economic growth and employment, rather than enforcing price stability, wrecked the world economy in the 1970’s and 1980’s. The outcome may not be much different this time around if Western central banks maintain their current monetary policies for much longer.

TILBURG – There are times for thinking and acting outside the box. And then there are times to return to normality. The West’s major central banks – the Bank of England, the European Central Bank, and the United States Federal Reserve – should take this to heart. As former Fed Chairman William McChesney Martin put it: “It’s the task of the central bank to take the punch bowl away when the party is still going.” Recently, however, the Fed decided not only to keep the punch bowl in place, but to refill it.

When the financial crisis erupted with full force in 2008, the world’s major central banks were right to employ exceptional measures. Granted, one could argue that in some cases they overshot – for example, with the second round of so-called “quantitative easing” in the US – but, roughly speaking, the response seems to have been appropriate.

More than two years later, however, the situation has changed. Economic recovery is not stellar, but it is a recovery nonetheless. Almost all developed economies have left recession far behind, and the danger of deflation has disappeared. The Swiss central bank recently adopted this position, and the ECB is worrying about higher inflation, not deflation, in the eurozone. In emerging economies, such as Brazil, China, India, and South Korea, inflation is rapidly rising and increasingly becoming an economic and social problem.

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