Unconventional Monetary Policy on Stilts
NOURIEL ROUBINI
NEW YORK – With most advanced economies experiencing anemic
recoveries from the 2008 financial crisis, their central banks have been forced
to move from conventional monetary policy – reducing policy rates via
open-market purchases of short-term government bonds – to a range of
unconventional policies. Although the zero nominal bound on interest rates –
previously only a theoretical possibility – had been reached and
zero-interest-rate policy (ZIRP) had been implemented, growth remained anemic.
So central banks embraced measures that didn’t even exist in their policy
toolkit a decade ago. And now they are poised to do so again.
The list
of unconventional measures has been extensive. There was quantitative easing
(QE), or purchases of long-term government bonds, once short-term rates were
already zero. This was accompanied by credit easing (CE), which took the form
of central-bank purchases of private or semi-private assets – such as mortgage-
and other asset-backed securities, covered bonds, corporate bonds, real-estate
trust funds, and even equities via exchange-traded funds. The aim was to reduce
private credit spreads (the difference between yields on private assets and
those on government bonds of similar maturity) and to boost, directly and
indirectly, the price of other risky assets such as equities and real estate.
Then
there was “forward guidance” (FG), the commitment to keep policy rates at zero
for longer than economic fundamentals justified, thereby further reducing
shorter-term interest rates. For example, committing to maintain zero policy
rates for, say, three years implies that interest rates on securities with up
to a three-year maturity should also fall to zero, given that medium-term
interest rates are based on expectations concerning short-term rates over the
next three years. Capping things off, there was unsterilized currency-market
intervention to boost exports via a weaker currency.
These
policies did indeed reduce long- and medium-term interest rates on government
securities and mortgage bonds. They also narrowed credit spreads on private
assets, boosted the stock market, weakened the currency, and reduced real
interest rates by increasing inflation expectations. So they were partly
effective.
Still, in
most advanced economies, growth (and inflation) remained stubbornly low. There
was no shortage of reasons for this. Given deleveraging from high private and
public debts, unconventional monetary policies could prevent severe recessions
and outright deflation; but they could not bring about robust growth and 2%
inflation.
Moreover,
the policy mix was suboptimal. While monetary policy can play an important role
in boosting growth and inflation, structural policies are needed to increase
potential growth and keep firms, households, banks, and government from turning
into zombies, chronically unable to spend because of too much debt. And fiscal
policies were also necessary to support aggregate demand.
Unfortunately,
the political economy of most structural reforms – with their front-loaded
costs and back-loaded benefits – implies that they occur only slowly. At the
same time, fiscal policy has been constrained in some countries by high
deficits and debts (which jeopardize market access), and in others (the
eurozone, the United Kingdom, and the United States, for example) by a
political backlash against further fiscal stimulus, leading to austerity
measures that undermine short-term growth. So, like it or not, central banks
became and still are the only game in town when it comes to supporting
aggregate demand, lifting employment, and preventing deflation.
As a
result, unconventional monetary policies – entrenched now for almost a decade –
have themselves become conventional. And, in view of persistent lackluster
growth and deflation risk in most advanced economies, monetary policymakers
will have to continue their lonely fight with a new set of “unconventional
unconventional” monetary policies.
Some have
already been implemented. For example, negative interest policy rates (NIRPs)
are now standard in Switzerland, Sweden, Denmark, the eurozone, and Japan,
where the excess reserves that banks hold with central banks as a result of QE
are taxed with a negative rate. Policymakers have shifted from working on the
quantity of money (QE, CE, and foreign-exchange intervention) to working on the
price of money (first ZIRP, then FG, and now NIRP). Nominal interest rates are
now negative not only for overnight debt, but also for ten-year government
bonds. Indeed, about $6 trillion worth of government bonds around the world
today have negative nominal yields.
The next stage of unconventional
unconventional monetary policy – if the risks of recession, deflation and
financial crisis sharply increase – could have three components.
First, central
banks could tax cash to prevent banks from attempting to avoid the
negative-rate tax on excess reserves. With banks unable to switch into cash
(thereby earning zero rates), central banks could go even more negative with
policy rates.
Second,
QE could evolve into a “helicopter
drop” of money or direct monetary financing by central banks of
larger fiscal deficits. Indeed, the recent market buzz has been about the
benefits of permanent monetization of public deficits and debt. Moreover, while
QE has benefited holders of financial assets by boosting the prices of stocks,
bonds, and real estate, it has also fueled rising inequality. A helicopter drop
(through tax cuts or transfers financed by newly printed money) would put money
directly into the hands of households, boosting consumption.
Third,
credit easing by central banks, or purchases of private assets, could broaden
significantly. Think of direct purchases of stocks, high-risk corporate bonds,
and banks’ bad loans.
If
unconventional unconventional monetary policies sound a little crazy, it’s
worth remembering that the same was said about “conventional unconventional”
policies just a few years ago. And if current conditions in the advanced
economies remain entrenched a decade from now, helicopter drops, debt
monetization, and taxation of cash may turn out to be the new QE, CE, FG, ZIRP,
and NIRP. Desperate times call for desperate measures.
About NOURIEL ROUBINI: an American Economist, is one of the top
global thinkers. He is one of the few economists who predicted the US housing
bubble crash of 2007-2008. He teaches at New York University's Stern School of Business and is the chairman of Roubini Global Economics,
an economic consultancy firm. Nobel laureate Paul Krugman adds that his
once "seemingly outlandish" predictions have been matched "or
even exceeded by reality. Media nicknamed him as “Dr.Doom” or “Permabear” for
his cautious views on global economy.
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