Loose monetary policy has not solved the world's economic problems

To be effective, monetary stimulus needs to be accompanied by temporary fiscal stimulus, which is now lacking in all major economies, writes Nouriel Roubini (who predicted the real estate bubble in the US).

By InvestSMART · 2 Feb 2015

By InvestSMART ·
2 Feb 2015

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Who would have thought that six years after the global financial crisis, most advanced economies would still be swimming in an alphabet soup – ZIRP, QE, CE, FG, NDR, and U-FX Int – of unconventional monetary policies? No central bank had considered any of these measures (zero interest rate policy, quantitative easing, credit easing, forward guidance, negative deposit rate, and unlimited foreign exchange intervention, respectively) before 2008. Today, they have become a staple of policymakers’ toolkits.

Indeed, just in the last year and a half, the European Central Bank adopted its own version of FG, then moved to ZIRP, and then embraced CE, before deciding to try NDR. In January, it fully adopted QE. Indeed, by now the Fed, the Bank of England, the Bank of Japan, the ECB, and a variety of smaller advanced economies’ central banks, such as the Swiss National Bank, have all relied on such unconventional policies.

One result of this global monetary-policy activism has been a rebellion among pseudo-economists and market hacks in recent years. This assortment of “Austrian” economists, radical monetarists, gold bugs, and Bitcoin fanatics has repeatedly warned that such a massive increase in global liquidity would lead to hyperinflation, the US dollar’s collapse, sky-high gold prices, and the eventual demise of fiat currencies at the hands of digital krypto-currency counterparts.

None of these dire predictions has been borne out by events. Inflation is low and falling in almost all advanced economies; indeed, all advanced-economy central banks are failing to achieve their mandate – explicit or implicit – of 2% inflation, and some are struggling to avoid deflation. Moreover, the value of the dollar has been soaring against the yen, euro, and most emerging-market currencies. Gold prices since the fall of 2013 have tumbled from $1,900 an ounce to around $1,200. And Bitcoin was the world’s worst-performing currency in 2014, its value falling by almost 60%.

To be sure, most of the doomsayers have barely any knowledge of basic economics. But that has not stopped their views from informing the public debate. So it is worth asking why their predictions have been so spectacularly wrong.

The root of their error lies in their confusion of cause and effect. The reason why central banks have increasingly embraced unconventional monetary policies is that the post-2008 recovery has been extremely anaemic. Such policies have been needed to counter the deflationary pressures caused by the need for painful deleveraging in the wake of large buildups of public and private debt.

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Frequently Asked Questions about this Article…

What are unconventional monetary policies and why are they used?

Unconventional monetary policies include measures like zero interest rate policy (ZIRP), quantitative easing (QE), and negative deposit rates (NDR). These tools are used by central banks to stimulate the economy, especially when traditional methods like adjusting interest rates are not effective, as seen after the 2008 financial crisis.

Why haven't the predictions of hyperinflation and currency collapse come true?

Despite predictions from some economists, hyperinflation and currency collapse have not occurred because the increase in global liquidity has not led to runaway inflation. In fact, inflation rates are low and falling in most advanced economies, and the US dollar has strengthened against other currencies.

How have gold prices and Bitcoin been affected by these monetary policies?

Gold prices have dropped significantly from $1,900 an ounce in 2013 to around $1,200, and Bitcoin was the worst-performing currency in 2014, losing almost 60% of its value. These trends contradict predictions that these assets would skyrocket due to unconventional monetary policies.

Why are central banks struggling to achieve their inflation targets?

Central banks are struggling to achieve their 2% inflation targets because of deflationary pressures. These pressures are largely due to the need for deleveraging after the buildup of public and private debt, which has made economic recovery slow and challenging.

What role does the European Central Bank play in unconventional monetary policies?

The European Central Bank (ECB) has adopted several unconventional monetary policies, including forward guidance (FG), zero interest rate policy (ZIRP), credit easing (CE), and negative deposit rates (NDR). In January, it fully embraced quantitative easing (QE) to stimulate the Eurozone economy.

How has the US dollar performed against other currencies?

The US dollar has been performing strongly, appreciating against the yen, euro, and most emerging-market currencies. This is contrary to predictions that the dollar would collapse due to unconventional monetary policies.

What is the main reason for the adoption of unconventional monetary policies post-2008?

The main reason for adopting unconventional monetary policies post-2008 is the extremely weak economic recovery following the financial crisis. These policies are necessary to counteract deflationary pressures and support economic growth.

Why do some economists' predictions about monetary policy outcomes fail?

Some economists' predictions fail because they confuse cause and effect. They overlook the fact that unconventional monetary policies are responses to economic conditions, not the cause of potential economic issues like hyperinflation or currency collapse.