Anumber of central banks in the advanced market economies, not least the U.S. Federal Reserve and the European Central Bank, have announced their intention to re-examine the analytical framework that guides them in the conduct of their monetary policy. Early indications imply that the fundamental results of these enquiries will be "more of the same."
What will not be questioned will be the primary objective of monetary policy. It will continue to be price stability. Nor will questions be raised about two other fundamental assumptions that have underpinned monetary policy in recent decades. First, it is taken for granted that ever-easier monetary conditions will suffice to stimulate aggregate demand. Second, easy monetary conditions have no significant unintended consequences for the economy.
Unfortunately, both of these assumptions are wrong. This implies that "more of the same" policies would also be wrong and likely dangerously wrong. At the very least, consideration of the uncertain economic implications of their policies should foster greater humility among ever-more experimental policymakers. This conclusion is strengthened by the recognition that post-crisis monetary policies have had political implications as well. These policies have widened wealth inequality, threatened the political "independence" of central banks, and have reassured governments that "business as usual" is a sustainable strategy--unintended and undesirable consequences.
There is a fundamental intertemporal inconsistency arising from the repeated use of monetary easing to stimulate demand. Initially, lower policy rates encourage private spending to be brought forward in time, with purchases being financed by debt accumulation. Over time, however, the weight of the debt burden accumulates and the effectiveness of further monetary easing declines. This is the feedback effect referred to by Alan Greenspan as "headwinds." However, what were in his time only headwinds have now grown to gale force.
Far from declining in the aftermath of the crisis that began in 2008, the ratio of global debt (households, corporates, and governments) to global GDP at the end of 2018 was 40 percentage points higher than it was in 2007. It is also a fact that the post-crisis recovery in the advanced market economies has been the weakest in the post-war period. Moreover, in virtually every year since the crisis, the growth rate of GNP projected for the next year by the International Monetary Fund and OECD has significantly overestimated the actual outturn. Forecasts for inflation have been similarly overestimated. In the emerging market economies, growth has been relatively more vigorous but is increasingly showing signs of weakness as debt levels ratchet higher.
In addition to the "headwinds" of debt, other arguments support the view that monetary easing might be less effective than many suppose. In The General Theory, economist John Maynard Keynes expressed his reservations: "If, however, we are tempted to assert that money is the drink that stimulates the system to activity, we must remind ourselves that there may be several slips between the cup and the lip." Ever more experimental policies raise levels of private unease, constraining "animal spirits" and leading to less spending, not more.
Nor is theory clear that ultra-low rates should induce more consumer spending. If consumers have a predefined goal for wealth accumulation, such as to ensure a comfortable retirement...