Unorthodox Monetary Policies: Watch Out for Unintended Effects

November 27, 2013

In the aftermath of the Great Recession, major central banks have scrambled to support economic recovery and to avoid deflation through highly accommodative and unorthodox monetary policy stances. Going forward, these central banks need to be much more mindful than they have been to date of the longer term unintended consequences of their policy actions, says Desmond Lachman, a resident fellow at the American Enterprise Institute.

Over the past five years, in the aftermath of the Great Recession, the Federal Reserve, European Central Bank (ECB), Bank of Japan (BOJ) and Bank of England (BOE) have pursued unorthodox monetary policies on an unprecedented scale. This has led to a massive expansion in these central banks' balance sheets and has taken monetary policy into entirely uncharted waters. These effects raise basic concerns as to how these central banks can successfully exit from these policies.

  • Since September 2012, the Fed has been engaged in an open-ended third round of quantitative easing (QE).
  • This has involved the purchase of U.S. Treasury bonds and mortgage-backed securities at a rate of $85 billion a month.
  • In addition, the Fed is providing forward guidance to the markets by indicating that it will not raise its policy rate so long as unemployment remains above 6.5 percent and inflation expectations remain well anchored.

It would seem that these policies have succeeded in providing welcome support to these economies' recoveries by substantially lowering long-term interest rates and by increasing asset prices. However, they have come with a host of unintended consequences, including incipient asset- and credit-market bubbles. They have also had important spillover effects on other economies in general and on the emerging-market economies. Recent capital flows and currency movements have been particularly disruptive to the emerging-market economies, which have been the main engine of global economic growth.

One has to hope that the world's major central banks strike the right balance between the short-run gains to be obtained from further QE and the longer-run adverse costs of those policies. In particular, one must hope that these banks refrain from repeating their past mistakes of unduly fueling asset- and credit-market bubbles and of contributing to undue exchange-market volatility.

Source: Desmond Lachman, "Global Effects of Unorthodox Monetary Policies," American Enterprise Institute, November 13, 2013.

 

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