The Take

The Pursuit of Inflation21/09/16

QUTEFS’ Publication Director, Nate Hentschel, covers the growing trend of monetary easing in this week’s edition of The Take:

The actions of central banks in controlling monetary policy often influences the domestic economy in powerful ways. While the aim of such policies is typically to achieve a variety of macroeconomic goals, altering the money supply can only achieve so much in the complex economies of today. The limits to what monetary policy can achieve are clearly visible when looking at countries experiencing chronic low cash rates since as far back as 2008. Japan, and now even Australia, have had central banks pursue record low cash rates in what have been largely unsuccessful attempts to stimulate growth since the Global Financial Crisis.

Even in recent times, less conventional techniques that involve using longer term assets to inject cash into the economy, such as quantitative easing, have not been successful in bringing inflation to the desired rate. The president of the European Central Bank, Mario Draghi, has suggested that monetary policy may be reaching the limit of what it can do to stimulate the economy in many countries.

Given this sluggish growth, and the pursuit of unusual aspects of monetary policy in the form of zero interest rates, negative interest rates, and easing, it is evident that there are limits to what conventional monetary policy can achieve as cash rates approach zero. Despite the best efforts of central banks, monetary policy as it exists today has limits in stimulating advanced economies, and other strategies need to be investigated.

Quantitative easing is a monetary technique which is designed to help increase liquidity and improve inflation to eventually stimulate the economy. A negative interest rate has the concept that cash will not be saved, and instead be loaned out and invested in tangible economic activities. Unfortunately, these policies are not the panacea to the problems of low interest rates. The negative impact which easing can have on the distribution of wealth, the value of assets and the allocation of resources has been documented in other countries which rely on easing to achieve what is, unfortunately, an unrealistic goal.

The ultimate concern with the pursuit of these policies is that many central banks are fearful of removing these policies. Because capital has been cheap for so long, it is likely that economic bubbles have formed in many markets, and thus raising interest rates carries the heavy risk of destabilizing these markets. This could cause even more damage in what is already an unsteady global economy. Now that markets have adjusted to low interest rates, cheap credit, and the effects of easing, to take away these factors would likely cause many dire flow on effects in the economy. Even the small interest rate rise in the United States in late 2015 caused a significant drop in the share market due to investor panic, and the Bank of Japan has recently announced a new long term monetary policy framework committing to low cash rates and easing, which caused a spike in the Tokyo Stock Exchange.

Despite the best attempts to stimulate economic growth via monetary policy, GDP growth in Australia has remained fairly low in recent years. It could be argued that a focus on such heavy expansionary monetary policies, and the pursuit of easing globally, has not helped aid in economic recovery and in fact may have even hindered it. These actions have not been able to produce tangible wealth, and in the long term they are unlikely to be successful in re-balancing our economy both domestically and globally. While Australia has yet to pursue such policies, with record low cash rates, one must ask: where to from here?