Why monetary policy doesn’t work very well

1. Why monetary policy
doesn’t work very well
Larry Hatheway
Jackson Hole Economics
larry@jheconomics.com

2. Overview
Has monetary policy reached its limits?
A decade of unprecedented easing, yet disappointing outcomes
 Unsatisfactory growth, excess global capacity
 Below-target inflation
Why is monetary policy not working very well?
 Monetary policy transmission channels are less effective:
• Consumption & investment are less responsive to low (negative) real interest rates
• Rising asset prices mostly benefit the few & those less willing to spend
• Money supply has grown, but so has money demand
• Inflation expectations have not responded
• When all central banks ease, none benefits from a weaker currency
• Policy errors have impaired central bank credibility
What is the answer?
 Take action to restore central bank credibility
 In extremis, coordinate monetary & fiscal policy
Source: JHE

3. Central banks have pushed down interest rates
$17trn of bonds with negative interest rates (Q3 2019)
0
1
2
3
4
5
6
7
8
Americas
Austria
Sweden
Belgium
Italy
Holland
Other
Spain
OtherEurope
Germany
France
Japan
Stock of negative yielding debt, $ trn
Source: Bloomberg

4. Central banks unable to boost inflation expectations
UK an outlier due to Bexit-related sterling weakness
Source: Bloomberg, JHE
UK
USA
Eurozone
Japan

5. Monetary policy frustrated by adverse shocks
Trade wars have taken their toll on manufacturing & trade
Source: Haver, Bloomberg, JHE
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ISM Export Orders ISM Manufacturing

6. Easy money has helped balance sheet repair
Household net worth has recovered from the great recession a decade ago
Source: Federal Reserve, JHE
 US household assets
 US household liabilities

7. WHATCAN
CENTRALBANKS
STILLACHIEVE?

8. This is how monetary policy is supposed to work
How monetary policy impacts the economy, in theory
Source: JHE
Central bank
cuts rates
Savings falls,
investment
rises
Currency
depreciates,
net exports
improve
Asset prices
rise, higher
wealth
boosts
demand
Inflation and
inflation
expectations
rise
#1
#2
#3
#4
#5

9. Why monetary policy is now less effective
The post crisis paradigm
Source: JHE
Central bank
cuts rates, uses
QE
Balance sheet
repair &
uncertainty
diminish impact
on demand
Other central
banks ease,
currency does
not depreciate
Asset prices
rise, but skewed
wealth
distribution
limits demand
impact
Inflation barely
budges
#1
#2
#3
#4
#5

10. Central bankers are partly to blame
Credibility matters…at times it has been squandered
Source: JHE
- Credible, Committed
- Early to explore unorthodox policies
- Forecast errors
- Independence under assault
- Poor communication: ‘Hear, but don’t listen’
- Policy error: Hiked rates in GFC, and in 2011
- Divided decision-making & messaging
- Weimar legacy undermines credibility
- Policy error: Hesitant response in 1990s
- Policy error: Hiked rates in 2001
- Burdened by deflation experience

11. The balance has tipped toward impotency
Obstacles now outweigh the efficacy of the tools
Source: JHE
Tools Obstacles