Central Banking's Grand Experiment
Central bankers, most of them versed in the history of the Great Depression and deflation, haven't been exactly reading from the same hymnal for the past few years. There are signs, though, that this might be changing.
Perhaps it is merely a coincidence, but the U.S., with the most activist central bank and after more than five years of quantitative easing and a zero interest rate policy, has the best looking economy in the developed world. Europe, where Germanic austerity and central-bank timidity prevails, looks the worst. Japan is somewhere in the middle, both in terms of its economic recovery and QE.
Preliminary results of these grand monetary experiments are now in and the results are clear: More monetary stimulus equals a strongest economic recovery.
Hey, maybe this isn't a coincidence after all?
Although the U.S.'s recovery hasn't been ideal, it is far better than what we see in Europe and Japan. Sure, it has been slow, unevenly distributed, with soft spots and blemishes. But it is a recovery nonetheless, one that is the envy of the developed world.
Perhaps that is why Shinzo Abe won the December 2012 election to return as prime minister of Japan. He pledged a radical break with the past, promising to “implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment.”
The Bank of Japan soon after began its version of QE, which was three times the size of the Federal Reserve’s relative to the size of the economy. Japan's QE is beginning to have the desired effect: After decades of deflation or near-deflation, inflation is starting to show. The yen has weakened, making Japanese goods more attractive to other nations. Unemployment has fallen, gross domestic product has risen and the Nikkei 225 has almost doubled. Abenomics, as these policies are collectively referred to, was working -- at least until an ill-advised sales-tax increase was allowed to go into effect.
While unconventional approaches have shown promise in the U.S. and Japan, the European Central Bank has taken a more timid approach. This is despite the fact that the economic situation in Europe is more dire than what we see in Japan or the U.S. It may very well get worse before it gets better.
In Europe, monetary policy is a prisoner of German paranoia. Hyperinflation of the Weimar era 90 years ago has created a Teutonic form of posttraumatic stress disorder. Despite disinflation and increasing signs of deflation, Europe is trapped by Germany's fears that rising prices will race out of control and lead to economic chaos that sparks social unrest. Fiscal policy also is a prisoner of austerity and unreasonable fears of budget deficits, a condition similar to that in the U.S., where political paralysis has hamstrung fiscal policy.
It is worth noting that opponents of central bank intervention and deficit spending in the U.S. have issued similar warnings for the past six years -- first inflation, then hyperinflation, then the inevitable collapse of the dollar. The next thing you know, the U.S. will be like Greece! Only none of these terrible prognostications came to pass. Instead, the U.S has seen significant improvements since the financial crisis: declining unemployment rates, reduced budget deficits, rising GDP and higher asset prices.
But the inaction in Europe is very worrisome and there are indications that things are getting worse. In Germany, we see early signs of an economic slowdown: Exports are falling, inflation is too low and both GDP and industrial production have been soft. Consumer and investor confidence has also turned pessimistic. The story is much the same in France and worse in Italy.
So we have three economies, with three central banks, each in a different phase of crisis response. The U.S. is the furthest along. The financial crisis began in the U.S. and it fell into a deep recession first. The U.S. also responded the quickest and with the strongest monetary (but not fiscal) remedies. The U.S. is now winding down its QE program, with the expectation that the economy is strong enough to withstand slightly higher interest rates.
Europe remains the slowest economy, with (not coincidentally) the weakest monetary and fiscal response of the developed nations. The euro-zone's misguided embrace of austerity has consigned the region to an economic holding cell that will be hard to escape without bold steps.
A new court opinion has now cleared the way for the ECB to join the U.S. and Japan in a bond-buying program. We will soon find out whether it has the brass to do so and join in central banking’s grand experiment.
We don't yet know what will be inscribed on the tombstones of central bankers of the present era. As for the Fed, perhaps its epitaph will be “At least we tried.”
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
To contact the author on this story:
Barry L Ritholtz at firstname.lastname@example.org
To contact the editor on this story:
James Greiff at email@example.com