NEW HAVEN, Conn. (Project Syndicate) — In what could well be a final act of desperation, central banks are abdicating effective control of the economies they have been entrusted to manage. First came zero interest rates, then quantitative easing, and now negative interest rates — one futile attempt begetting another.
Just as the first two gambits failed to gain meaningful economic traction in chronically weak recoveries, the shift to negative rates will only compound the risks of financial instability and set the stage for the next crisis...
This could be the greatest failure of modern central banking...
...most major central banks are clinging to the false belief that there is no difference between the efficacy of the conventional tactics of monetary policy — driven by adjustments in policy rates above the zero bound — and unconventional tools such as quantitative easing and negative interest rates...
Two serious complications have arisen from this approach.
The first is that central banks have ignored the risks of financial instability.
Drawing false comfort from low inflation, overly accommodative monetary policies have led to massive bubbles in asset and credit markets, resulting in major distortions in real economies. When the bubbles burst and pushed unbalanced economies into balance-sheet recessions, inflation-targeting central banks were already low on ammunition — taking them quickly into the murky realm of zero policy rates and the liquidity injections of quantitative easing.
Second, politicians, drawing false comfort from frothy asset markets, were less inclined to opt for fiscal stimulus — effectively closing off the only realistic escape route from a liquidity trap. Lacking fiscal stimulus, central bankers keep upping the ante by injecting more liquidity into bubble-prone financial markets — failing to recognize that they are doing nothing more than “pushing on a string” as they did in the 1930s.
The shift to negative interest rates is all the more problematic. Given persistent sluggish aggregate demand worldwide, a new set of risks is introduced by penalizing banks for not making new loans. This is the functional equivalent of promoting another surge of “zombie lending” — the uneconomic loans made to insolvent Japanese borrowers in the 1990s.
Central banking, having lost its way, is in crisis. Can the world economy be far behind?
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