The U.S. Federal Reserve building in Washington.JIM YOUNG
Ranga Chand is an international economist and is president of Chand Carmichael & Company
When the global financial crisis erupted following the collapse of Lehman Brothers in 2008, the world's major central banks moved quickly to prevent the world economy from falling into a credit-led depression. By sharply lowering interest rates in a series of cuts to record low levels they succeeded in preventing another 1930s style Great Depression from taking hold. But, despite the persistence of ultra-low interest rates since then, growth in the advanced countries has failed to get onto a firmer footing.
Unable to push rates below the zero bound, the world's major central banks have been turning on the electronic spigots and flooding the global financial system with liquidity through a policy of quantitative easing. Since the financial crisis, the U.S. Federal Reserve has more than tripled the size of its balance sheet while the other major central banks have doubled theirs. As a per cent of GDP, the balance sheets of the major central banks now range from 19 per cent in the case of the Federal Reserve (up from 6 per cent in 2007) to 32 per cent for the European Central Bank, up from 17 per cent. Collectively, the balance sheets of these central banks have skyrocketed, rising from $4-trillion in 2007 to over $9-trillion in 2011.
By creating new money to buy up government debt and other financial securities from commercial banks and other financial enterprises, the goal of QE was to boost economic growth, increase inflation, and lower the unemployment rate. However, when one examines the impact of quantitative easing, it is apparent that the policy has misfired. After an initial spurt, economic growth has started to slow sharply in the advanced countries, job creation has been weak, and the unemployment rate is still well above pre-recession levels.
The problem is that QE is a very indirect way of trying to stimulate the economy. While QE has helped to recapitalize banks, which continue to focus on repairing and purging their balance sheets from toxic assets, it has done little to help the flow of credit to the real economy. Despite a super-accommodative monetary policy, credit conditions still remain tight particularly for small and mid-sized companies.
Trying to force feed economic growth by saturating the system with trillions of dollars when households and governments are deleveraging has proved to be an ineffective way to spur the recovery. A better approach would be for the central banks to intervene directly into the economy by lending money to small and mid-sized companies who in the main are the lead generators of employment.
Although the whole gamut of monetary policy needs a re-think, central bankers appear determined to stay the course. Indeed, the Federal Reserve has indicated that it intends to keep rates at near zero levels until well into 2014. And, there is talk that they may be preparing for another round of QE in the (vain) hope that flooding the system with even more money will eventually lead to an upsurge in growth.
Obviously, no one is paying heed to Japan's decade's-long slump. More's the pity.