Anyone who back in 2008 had accurately predicted what monetary policy would look like today would certainly have been regarded as unhinged.
Quantitative easing (QE) was introduced as an emergency measure to prevent the collapse of troubled financial institutions and to stimulate the economy. Over a decade later, what was conceived as a temporary action has become an almost permanent feature of western economies.
Indeed, as recently as early this year there was talk of an imminent shift from QE to quantitative tightening (QT). But by June, with European Central Bank (ECB) President Mario Draghi’s speech in Sintra, it became clear the tide was not turning, after all. This September, the ECB extended its QE programme and the US Federal Reserve cut rates.
It is not hard to see why central banks have pursued such a policy. They have opted to maintain short-term stability rather than, by raising rates, taking a measure that could hurt the corporate sector and employment. When posed in these terms – stability versus pain – it seems to make sense to opt for the former.
The problem is that it is a short-term approach. In the longer run it is likely to lead to greater instability and more pain. It has already intensified the problem of chronically low productivity growth.
To understand the problems inherent in extended QE, it is necessary to appreciate the role of recessions in a capitalist economy. Essentially they perform a healing process in which weaker companies fail and new dynamic firms emerge. This restructuring is often referred to as ‘creative destruction’.
Thwarting this process only creates more problems. Most obviously there are ‘zombie companies’ – firms that only survive thanks to the supply of cheap credit. According to a 2018 OECD study, some 10% of firms across developed markets could be classified as zombies.
The flip side of the prevalence of zombies is the dearth of dynamic firms. In the absence of an economic restructuring, it becomes harder for innovative new companies and new sectors to emerge. That helps explain why productive growth has stalled.
There is also a broader effect on the corporate sector. Without a necessary restructuring it has become flabby. There is relatively little incentive to engage in capital investment to bolster businesses for the future.
Ultimately, extended QE is unlikely to achieve its original goals in any case. It is only storing up more intense problems of financial instability and economic lethargy for the future.
Daniel Ben-Ami, Deputy Editor