No heart is immune from the uplifting tale of the Little Engine That Could—that plucky optimist who, against the odds, saved the day by chugging a stranded train over a mountain. In the world of economics, our central bankers have become this storybook overachiever. Ever since the 2008 Wall Street meltdown, they have tried, tried, and tried again to pull the broken global economy into happier times, undaunted by setbacks, criticism, or the sheer weight of their burden. At times that unstinting effort has made them heroes, too. The now-legendary 2012 pledge by Mario Draghi, president of the European Central Bank, to do “whatever it takes” to save the euro quelled the market turbulence that threatened to tear apart Europe’s monetary union.
Today, though, central banks look more and more like the Engines That Couldn’t. Despite all their tireless persistence, the world economy remains stuck on the tracks, short of its ultimate destination—a real recovery. The value of the often highly unorthodox methods central banks have employed along the route will be hotly contested by economists for years, even decades. What’s beyond question is that the institutions just don’t possess the horsepower to rescue the global economy.
That hasn’t stopped economists and investors from pressing central banks to do even more. Draghi in early March dropped the ECB’s interest rates to record lows and expanded an unconventional bond-buying program—called quantitative easing, or QE—aimed at tamping down rates even further. The Bank of Japan is widely expected to take more measures to boost that slumbering economy. In the U.S., the December decision by Federal Reserve Chair Janet Yellen to raise the benchmark interest rate, after seven years near zero, has been criticized by some analysts as a mistake, and she’s recently signaled that interest rates would be raised more slowly than previously anticipated.
The pleas for more central bank action seem to make perfect sense. Markets in the U.S. have been in turmoil, and the economy, though stronger than most others in the developed world, is definitely not roaring. Europe and Japan, struggling to grow and combat deflation, are in far worse shape. Under such circumstances, central banks usually ease monetary policy, making money cheaper to stimulate economic growth and prices. In the case of Japan, Marcel Thieliant, senior Japan economist at research firm Capital Economics, insists that “more easing is surely needed.”
Yet the fact that the world’s advanced economies are in such feeble condition argues that easier money won’t solve their problems. After all, central banks have already been gunning their engines at full throttle for seven years. Interest rates remain remarkably low—in Japan and the euro zone, they’re at zero. The ECB and BOJ have even resorted to negative interest rates, actually charging depositors for holding cash, in an attempt to force banks to lend and businesses to invest. And although the Fed wound down its six-year QE program, the ECB and BOJ continue to buy bonds on a massive scale.
There’s no consensus on how much these cash-injecting maneuvers have aided the real economy—or helped at all. Supporters of Fed policy, for instance, insist that its easy-money strategy successfully shepherded the U.S. through the Great Recession and into a period of stable growth with near full employment. At worst, they contend, the Fed prevented the economy from tumbling into an even deeper downturn. Detractors, however, blame the Fed for causing a litany of ills—exacerbating income inequality, encouraging a spendthrift government, inflating a stock market bubble, roiling emerging economies—while contributing little to the American revival. Even Fed officials don’t agree about the effectiveness of their own policies. One 2015 study, by researchers at the Federal Reserve Board, figures that the Fed’s program made a significant contribution to reducing joblessness, while another, penned by Stephen Williamson, vice president at the Federal Reserve Bank of St. Louis, asserted that “there is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed—inflation and real economic activity.”
The limits of central banking are more apparent in Japan. In 2013 newly installed BOJ Governor Haruhiko Kuroda embarked on a gargantuan stimulus program aimed at smashing endemic deflation, encouraging borrowing and spending, and restarting growth in an economy that’s stagnated for more than two decades. But no matter how quickly Kuroda has run his printing presses, the impact on Japan’s outlook has been negligible. The economy tumbled into recession in 2014, and gross domestic product has contracted for two of the past three quarters. Prices, by one commonly used measure, didn’t change at all in February from a year earlier.
The ECB hasn’t fared much better. In early 2015, Draghi caught up with his peers and began his own QE program to ward off a Japan-style deflationary spiral. But prices in the euro zone receded 0.2 percent in February. The zone’s GDP expanded an uninspiring 1.6 percent in 2015, and the outlook for this year isn’t expected to be any better, while unemployment is stubbornly high at 10 percent.
Meanwhile, there are indications that central banks have already gone too far. In Japan, the BOJ’s policies have so distorted prices that on March 1 the government sold benchmark 10-year bonds at a negative yield for the first time. Yes, investors made the otherwise illogical decision to lend the government their money and pay for the privilege of doing so. In turn, that alleviates the urgency for the Japanese government—the most indebted in the developed world—to rein in its budget deficits. Lawmakers and economists fear that the use of negative rates in Japan and Europe will damage consumer sentiment and the health of banks. Even other central bankers are raising concerns about their compatriots’ decisions. At a conference in Shanghai in February, Bank of England Governor Mark Carney complained that negative interest rates can weaken currencies, helping countries to benefit at the expense of others.
In the desperate quest to revive the global economy, it seems we’ve all forgotten what we learned in college economics. Monetary policy is and always will be an indirect science. Central banks can pump money into an economy, but unless investors, companies, and consumers use it to build factories, start enterprises, or buy cars, the flood of cash won’t boost growth. In the end, it’s the demand for money that counts as much as the supply.
That’s exactly what’s gone wrong in Japan. Deflation isn’t just a cause of the economy’s paralysis but also a symptom of deeper constraints on growth. Japanese companies are too burdened by high costs, wrapped up in red tape, and wedded to outdated business practices to take advantage of cheap cash. That shows printing money is no substitute for real economic reform. Prime Minister Shinzo Abe has leaned on Kuroda to solve economic problems he’s been politically unwilling to tackle. The reform arm of his policy platform, known as Abenomics, did make some progress, joining the Trans-Pacific Partnership free-trade agreement, for instance, and bolstering corporate governance rules. But it hasn’t seriously addressed major flaws that hamper growth and welfare, such as a dual-track labor market that condemns too many workers to temporary jobs with little training or opportunity to advance.
The same has happened in Europe. Draghi’s exertions were never matched by the euro zone’s complacent political leaders. The austerity-obsessed approach to debt crisis, imposed by German Chancellor Angela Merkel, wasn’t offset by growth-enhancing reforms at the European level, such as removing remaining barriers within the common market. Individual nations, from Germany to Greece, haven’t done enough to fix their own economies. In the U.S., Yellen could have benefited from a helping hand from Washington, but Congress has been too gridlocked by, among other things, the ideological stubbornness of the Tea Party wing of the GOP to take measures that could boost the nation’s competitiveness.
So to be fair to Yellen, Draghi, and Kuroda, we’ve expected too much from them. Central bankers simply can’t solve our economic problems on their own, no matter how hard they try. Ultimately, the poor post-crisis recovery was the fault of political leadership. Central banks had the power and will to step into the breach, and they heroically took up the burden. But it proved too heavy. Their engines have just run out of steam.