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The time to phase out unconventional monetary policy is now

    Following the 2007/8 global financial crisis, major central banks around the developed world resorted to the use of unconventional monetary policies. Most central banks – including the Bank of England (BOE), the Federal Reserve (FED) and the European Central Bank (ECB) - reduced interest rates to record lows. Some central banks like Bank of Japan and the Bank of Switzerland resorted to slashing interest rates that resulted in rates being pushed into negative territory. Along with changes to interest rates, central banks also undertook large scale purchases of outstanding debts, the practice commonly known as Quantitative Easing (QE). Although these policies had a stabilising effect on financial markets and employment during the crisis, slow recoveries post-crisis in many advanced economies have raised questions about their benefits in normal times.

    It is believed that unconventional monetary policies adopted during the crisis have had negative effects on investment and have even led to a misallocation of capital. The presence of mostly free money available to commercial banks has affected the structure of money market. Commercial banks have now become dis-incentivised from acting as credit suppliers in the money market and have resorted to substituting inter-bank lending with borrowings from the Central Bank. Aside from their impact on the money market, these policies may have also motivated governments to stray away from undertaking effective structural changes and making productive investments, rather than increasing their spending on unproductive consumption, as is current practice. 

    The wealthiest 1% in UK currently own 14% of the nation’s assets (worth £11 trillion) in contrast to 15% of the population which owns no assets at all or is in debt. This stark difference between assets held by different groups of society highlights the wealth disparities that are on the rise in the UK. A study by S&P indicates that unconventional monetary policy – in particular the use of QE - has contributed to the widening of these wealth disparities in the UK. The availability of cheap credit has led to a further increase in the wealth of highest income groups who have accumulated this wealth through investments in financial assets and real estate. Even the dramatic price increases in the housing market, which have outpriced the young and low-middle income groups from purchasing houses, can be partially attributed to the adoption of these policies.

    Unconventional policies followed by developed economies had spill-over effects in emerging economies. The presence of globally connected financial markets has led to a flow of easily available credit in developed economies, to emerging economies. These economies, which include China, Brazil and India, have seen both an inflow of capital and an increase in equity prices. The availability of cheap credit flowing in from abroad pushed these economies to undertake unproductive investments, oversupply their markets and accumulate mounting levels of debt, all of which is starting to unravel following the decision of the FED to move away from the use of these policies.  

    Although there is a growing body of research indicating that these policies have not yielded desirable effects post the financial crisis, central banks seem determined to carry on applying the same formulas expecting a different result. By prolonging the use of these policies, the BOE is making it difficult for itself to formulate viable measures to deal with future crises. The ineffectiveness of these policies indicates a need for the BOE to put an end to ultra-loose monetary policy - an idea supported by a member of its Monetary Policy Committee who points to the encouraging job growth data as an indication that the time to end these policies has come.

    It is unlikely that the transition away from QE will be simple. Nevertheless, the BOE needs to seriously consider a withdrawal from the use of such policies before the economy suffers more of the negative side effects that arise from the implementation of these policies during normal times. 

    Shruti Dayal is a CPS Summer 2017 Economic Research intern. She graduated in 2017 with a degree in Economics (Hons.) from the University of Warwick, and is interested in working in consulting and research. 

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