On life support
Following the global financial crisis, central banks were quick to act, injecting monetary stimulus and effectively providing life support to markets amid a failure of confidence in the broader banking system.
Arguably, this provided much-needed liquidity cover at the peak of the crisis and was a sensible governance response that probably contained what could have been a far worse outcome.
After conventional monetary policy, ie cutting interest rates, was exhausted, an increasingly desperate central banking fraternity turned to the unconventional and still highly experimental approach of quantitative easing.
Part of the idea behind quantitative easing is not simply to pump money into the system but to bypass dysfunctional banking systems and get money into the ‘real’ economy. In this respect, it was only partially successful.
While quantitative easing bypassed the banking system, the resulting money flows remain caught in the financial system, with the excess liquidity pushing up asset prices but not generating any more than lacklustre economic growth.
There are clear reasons for this. While unconventional monetary policy can avert a liquidity crisis, it cannot fix underlying solvency and structural challenges. It merely provides cover for much-needed re-capitalisation and reform.
Another avenue is that quantitative easing boosts asset prices, which tends to make the asset-rich even richer, but this cohort also has a much lower propensity to spend, limiting the pass-through to the real economy. Pushing up asset prices without boosting the underlying economy leads to overpriced assets, resulting in markets that become addicted to and dependent on monetary stimulus.
One result is the quite unhealthy rallies witnessed during the past few years, where disappointing economic data have been rewarded by markets anticipating further monetary stimulus like Pavlov’s dogs.
Unfortunately, the efficacy of such unconventional policy is starting to fail, with central bankers recognising they are running out of treats with which to feed the pack.
