Have we reached the limits of monetary policy? No. The central banks’ medicine cabinet is still full. Yet using the old treatments more aggressively or using altogether new treatments creates political, financial and economic risks. Worse, such action cannot solve some of the bigger difficulties the high-income economies confront. In an ideal world, therefore, monetary policy, should not remain “the only game in town”, as the title of a book by the economist and investment manager Mohamed El-Erian suggests it now is. Unfortunately, we do not live in an ideal world. In the real world, central banks must remain our doctors of choice.
Central banks have duly employed more radical treatments than ever before. All the leading central banks of advanced economies have set short-term intervention rates close to zero. The Bank of Japan has applied rates this low since 1995. The US Federal Reserve and the Bank of England have used ultra-low rates since early 2009. By 2013, the European Central Bank followed suit — albeit too slowly.
These central banks have also substantially expanded their balance sheets through quantitative easing or, in the case of the Bank of Japan, “quantitative and qualitative easing” (which includes lengthening of the maturity of the assets it buys). Like the Fed, the Bank of England has stopped purchasing assets. But its balance sheet is bigger, relative to UK gross domestic product, than throughout its long history. The BoJ and ECB are still expanding their balance sheets today (see charts).