Last Thursday, the European Central Bank announced its latest stimulus measures, which many observers characterized as a quantitative easing, or QE, “bazooka.” The initiative was comprised of several components: four rounds of targeted long-term refinancing operations, which feature loans to banks that are designed to encourage lending to businesses; an increase in the ECB’s bond-buying program, together with an expansion in the range of assets eligible for purchase; and a series of interest-rate cuts, including the lowering of the central bank’s deposit rate from -0.3% to -0.4% and benchmark lending rate from 0.05% to 0%.
Markets initially cheered the news, but subsequently reversed course amid jitters about the efficacy of such measures and questions about whether easy-money policymaking had reached its limits. On Friday, sentiment warmed again and risk markets recovered on renewed faith that the moves would ultimately prove supportive for liquidity, the banking system and the economy.
But was the euphoria that closed out the week justified? In other words, will the actions of the ECB–or other central banks, for that matter–have the desired–or intended–effect? More generally, will the large-scale experiment that the institutions have been carrying out work out as planned? Are the expectations that they will lead the world out of malaise grounded in reality?
Unintended consequences and unwelcome side effects
Some would say “no.” While there is not much doubt that ultra-aggressive accommodation during the post-financial crisis era has bolstered asset prices, especially equities, a casual glance across the economic landscape suggests that at least some of the policymakers’ efforts, especially those aimed at driving borrowing costs lower, have had unintended consequences and unwelcome side effects.
More specifically, the notion that zero or negative interest rates would encourage more spending by individuals, lead to increased borrowing by businesses for investment, and induce banks to boost their lending to the corporate sector to augment their returns has not quite worked out.
In fact, the opposite looks to have held true. Individuals who have seen returns from fixed-income holdings shrink–especially the older generation, which has traditionally depended on such investments for their survival–have either increased their savings to try to make up the difference, or have shifted savings into riskier parts of the financial system, setting the stage for the sort of turbulence that was seen earlier this year–foreshadowed here–and helping to weaken system-wide underpinnings.
Difficult for all involved
The impact of reduced financing costs on the business community also looks to have been less beneficial than policymakers anticipated. On the one hand, businesses that should have been put out of their misery or that have only barely held on in the aftermath of the crisis have used artificially low rates as a desperate lifeline, which has only served to prolong their misery and make operating conditions more difficult for all involved, including better managed rivals.
On the other hand, businesses that have been efficiently run or that had sufficient resources to weather the upheaval of seven years ago seem to have decided that it doesn’t make sense to plan too far into the future or to take on potentially lucrative long-term commitments, even if they could be funded at a rate that is unlikely to be beaten at any time in the future.
Most likely, this is because easy money policies leave them without a realistic sense about the true underlying health of the economy, the appropriate levels for asset prices, future growth prospects, and the threats that might be lurking when central bank support eventually comes to an end.
Distorted, or nothing at all
Not surprisingly, large public companies, for example, have increasingly focused their attentions on financial engineering and penny-wise/pound-foolish strategizing (including reducing outlays on research & development), and have adopted an almost pathological focus on higher stock prices. At the other end of the spectrum, many smaller businesses have simply continued to struggle because unprecedented monetary accommodation has not trickled down.
In the financial sector, the post-crisis monetary policy experiment hasn’t done much to expand banks’ and other intermediaries’ willingness and ability to help improve economic conditions, or to strengthen the foundations of the industry, which was undoubtedly in dire straits at the peak of the crisis.
Instead of lending more to help companies grow, many financial institutions have instead capitalized on their unique relationship with central banks to capture riskless profits. Rather than shrinking to a manageable and less systemically-risky size, becoming more efficient, and reducing exposure to activities that contributed to past woes, they have largely carried on as before. Many of those that should have been allowed to fail remain needlessly alive, while those that were too big to begin with have become an even greater threat to the financial system.
Inequality and divisiveness
Then there are the social costs of central bank policies that were ostensibly designed to improve economic life. The fact that equities, which are among the riskiest of assets, have been among the major beneficiaries of central bank largesse has played a role in fostering rising inequality, while the social contract that once aligned various business stakeholders, including employees and the community, has been steadily torn apart.
The fact is, while many in the financial world continue to view the actions of central banks in a positive light, there are numerous signs that this perspective is misguided. Those who are betting that more of the same from policymakers is a recipe for more of the same on Wall Street and Main Street may be in for an unpleasant surprise.