A phenomenal expansion of central bank balance sheets has taken place in the aftermath of the global financial crisis, as central banks have aggressively pursued several types of unconventional monetary policy measures. In virtually all cases, it has involved liquidity and credit facilities, as well as outright asset purchases. In some cases, it has also involved forward guidance; that is, policy commitments conditional on future economic developments.
The effectiveness of these unconventional measures has been hotly debated. Central banks have presented evidence that bond yields have come down, estimating the cumulative effect to have been from around 50 to 120 basis points at 10 years, and have argued that portfolio rebalancing, wealth effects and signalling have all been positive for growth. Those on the other side of the debate, however, worry about the ability of central banks to unwind unconventional policies without generating significant uncertainty and volatility in markets, along with expressing concern about the risk of asset price bubbles or generalized inflation from prolonged monetary accommodation.
Doing the counterfactual — what would have happened in the absence of these unconventional policies — is difficult, given the limited experience we have had with such measures. The balance of evidence, however, supports the view that the global economy would be worse off today if central banks had not taken these extraordinary actions.
All indications point to the likelihood that we will be living with unconventional monetary policies for some time. While Federal Reserve Chairman Ben Bernanke has raised the possibility of a slowing in the pace of asset purchases, it would be conditional on a steadily improving US labour market and economy (that is, data determined). Financial markets, being naturally forward looking, have nonetheless already begun to critically assess and react to what some are calling “the beginning of the end of easy money”; we have seen US treasuries back up significantly in response. In the United Kingdom, the continued commitment to fiscal consolidation almost certainly rules out any unwinding of unconventional policies any time soon. The European Central Bank seems to have embraced forward guidance. And in the case of Japan, an aggressive expansion of the Bank of Japan’s balance sheet has just been launched.
Given the state of the global economy, unconventional monetary support should continue to be an important part of the policy mix to promote global economic recovery and growth. But is it enough?
The challenges the global economy faces require far more than just a continuation of unconventional monetary policies to secure recovery and growth. While more can, and in some case should, be done by central banks, the limits of monetary policy need to be recognized. The time these policies have offered for other policies to be put in place and take hold may be running out.
In advanced G20 economies, we have a deficiency of demand, with unemployment remaining unacceptably high, and still rising in some jurisdictions. Balance sheets remain impaired with pressures of deleveraging and unsustainable debt levels still very evident. Implementation of financial sector reforms is far from complete. And there is a pressing need for real sector structural reforms, ranging from product and labour market reforms to tax reforms to address the challenges of today’s global economy.
In the euro zone, the pace and degree of austerity needs to be recalibrated, banks need to be recapitalized and substantially more debt restructuring is required. When the Fed deems it appropriate to begin reducing its pace of asset purchases, a durable expansion — underpinned by more than just monetary policy — must be a prerequisite if the inevitable rebalancing of portfolios is to be absorbed smoothly. In the UK, restoring the health of its banking system must take on renewed urgency. And in Japan, clear and effective communications are needed to avoid market missteps about its bond-buying program.
In advancing G20 economies, as the engine of global growth since the onset of the crisis, their main near-term task is to continue to adjust the macroeconomic levers of policy to support sustained growth. Given the differentiation across countries, these policy responses vary. A complicating factor has been the spillovers from the policies of advanced economies, including the market gyrations surrounding recent Federal Reserve communications about its pace of asset purchases. Still, key variables such as exchange rates have broadly reflected medium-term fundamentals.
The other critical challenge for advancing economies is to engineer key structural changes in recognition of underlying, longer-term global forces at play, including their own rising presence and importance. These policies include those to support a shift of resources to growth-oriented sectors, promote sound and transparent regulations and encourage more reliance on the price mechanism as a way of doing business. In China, recent concerns among authorities about the rapid rate of credit expansion and growing presence of a shadow banking system underscore the importance of placing priority on moving in the direction of interest rate and exchange rate market reforms, even if these are deemed among the hardest to do.
Success in all these areas of structural reform requires policy platforms with clear roles and responsibilities. It is when there is a lack of clarity, or a perceived vacuum, about policy objectives and frameworks that problems arise.
Paul Jenkins is a distinguished fellow at The Centre for International Governance Innovation and a former senior deputy governor of the Bank of Canada.