Out of ideas, out of money, the world's central bankers and governments are now caught in a low inflation rate trap after the failure of quantitative easing. What's more, few are showing an appetite to take the tough decisions to get out of this rut.

Central bankers in the US and Europe have run out of ideas. Their main policy tool since the financial crisis has been easy monetary policy by way of quantitative easing (QE). But with both growth and inflation persistently low they are now turning to more radical ideas such as zero and negative interest rates. 

This is likely to make things worse rather than better. Some economists think that rather than producing growth and inflation as desired, persistently low interest rates actually do the opposite – they lead further down the road of deflationary stagnation. 

Pimco’s chief investment officer, Scott Mather, says in a blog that “groupthink monetary policy leads to a zombification of the economy”.

In a recent paper entitled The World Economy’s Slow Puncture, HSBC says that if banks cannot pass on negative interest rates to depositors they are effectively a tax on banks. “As a result, the banks’ willingness to take on more deposits will be lowered, limiting their role as financial intermediaries,” says the research paper. “Other things equal, if banks turn depositors away, the money will end up under the mattress…”

With the failure of both QE and negative interest rates, cries have come from some quarters to do the central bankers’ equivalent of the traders’ double-up – betting even more cash on a position that has moved against you. This would be the impact of helicopter money – in effect allowing the central bank to monetise government debt, a policy historically associated with Latin American dictatorships and failed states. The result would be a general loss in confidence and a further rush to put money under the mattress. 

What central bankers should do instead is accept that they have run out of road and that the way forward now is through restructuring and reform by both governments and companies. They should set rates at a moderately positive level based on historical trends and do nothing else. 

Many central bankers have called for reforms but as long as politicians and chief executives think that monetary policy provides an easy way out for them, they will do nothing. 

Let’s take companies first. The HSBC paper says: “Higher values for financial assets [caused by QE] meant that companies which, in other circumstances, would have been under pressure to reduce their costs could carry on with business as usual.”

As a result they did not embark on the painful process of restructuring through laying off workers and rebuilding but rather carried on absorbing capital that would be better allocated to more dynamic enterprises. “It was perhaps a Western version of the Japanese zombie company problem,” says the HSBC paper. 

If companies are sitting on their hands then governments are in a deep sleep. They need to release resources from welfare spending and get them invested in education and infrastructure but the political cost of doing this is usually unpalatable. It’s easier to duck hard choices and leave it to the central bank. 

Finally there are sensible calls to expand trade which should be, and is not, expanding faster than world GDP to give any hope of a lasting recovery. General commitment to free trade as a common good that everyone benefits from – the approach of the World Trade Organisation – has been replaced by the idea that access to markets is a political bargaining tool. The EU, for example, considers its single market something that other countries should pay to access rather than providing the comparative advantages promised by classical economics.

Brian Caplen is the editor of The Banker.

Order The Banker July edition

Join our community

Request a demonstration to The Banker Database

Demetrio Salorio, global head of debt capital markets, Société Générale - View from IMF 2018

The Banker's editor Brian Caplen talks to the global head of debt capital markets at Société Générale, about how some emerging markets are under pressure and what this means for bond issuance.

Watch more videos

The Banker on Twitter

By continuing to use this site you consent to the use of cookies on your device as described in our cookie policy unless you have disabled them. You can change your cookie settings at any time but parts of our site will not function correctly without them.