The negative side effects of easy money are starting to grow and, at this point, central banks are doing more harm than good, said the former Chief Economist at the Bank for International Settlements (BIS).
In a phone interview with Financial Sense, William White, now chairman of the Economic and Development Review Committee at the OECD, discussed his recent Adam Smith Prize lecture, "Ultra-Easy Money: Digging the Hole Deeper?", which he gave before the National Association of Business Economists.
Monetary Policy Failed to Stimulate Aggregate Demand
White said easy monetary policies were needed during the 2008 financial crisis in restoring confidence but then took a wrong turn around 2010 when attempting to boost economic growth.
“The policy stakes are now very high” since “ultra-easy policy has not stimulated aggregate demand to the degree expected.”
“I see a curve where the efficiency of monetary policy goes down with time, and the harmful side effects of policy go up with time,” White said. “At some point, those two curves intersect, and the central banks are doing more harm than good. My feeling is this has been the case for quite some time.”
Machine vs. Complex Adaptive System
“The error is that we assume the economy is a kind of machine that is both understandable in terms of its operation, and therefore controllable,” White said. “The economy is not understandable and controllable. It’s not a machine. … It’s a complex adaptive system. And it’s a system that is so complicated, and so constantly changing, that it's just naïve to think that you can understand it, much less control it.”
This fundamental misunderstanding is causing central banks to fall back on old models and belief systems rather than rethinking their assumptions. The big worry is they'll simply double down on monetary policy even though it hasn't worked, said White.
Just this week, Janet Yellen said that the U.S. central bank may need to expand their range of tools and buy equities or corporate bonds to boost the economy in a downturn, the WSJ reported.
Financial Instability Ahead
The former Chief Economist for the BIS said central banks are intruding on markets and affecting their functioning as a result.
“Financial markets don’t seem to be working the way they [once] did,” he said. “The whole price discovery mechanism has disappeared.”
Because of this, White went through a very detailed list of adverse consequences, which lead to an increasing risk of financial instability, as monetary policies are pushed to their limits.
A Better Way Forward?
“The problem is, given where we are, there are no other options on the table, other than the ones I’m suggesting,” White said.
He argued we need a series of policies both on the demand side and the supply side, including fiscal action from countries that have room to maneuver. There also needs to be more emphasis on wage growth and on credible legislation that will lead to a framework for sustainable debt levels.
“Debt levels globally are actually 20 percent of GDP higher now...than they were in 2007,” White said. “So we haven’t gone through a period of deleveraging. I think we need to address the question of debt sustainability, debt structuring, bankruptcies and associated legislation much more carefully than we’ve done up until now.”
Since problems with debt and leverage have only grown worse, there’s a desperate desire to believe central bankers have everything under control, White stated.
But they don't, he said. “That’s the reality.”
Listen to this full interview with William White, chairman of the OECD's Economic and Development Review Committee and the former Chief Economist at the BIS, by logging in and clicking here. Not a subscriber? Click here
