With the global economy still struggling to emerge from the Great Recession, the world’s central bankers have stepped in yet again in an attempt to spur growth and strengthen the recovery. In mid-September, the Federal Reserve announced it would extend its bond-buying program to bring down long-term interest rates and stimulate investment and employment. Federal Reserve Chairman Ben Bernanke said the effort, being called QE3, will “employ our policy tools as appropriate” until the U.S. finally sees a jobs recovery. In Europe a few days before, European Central Bank (ECB) President Mario Draghi inserted himself to ease the euro zone’s debt crisis. He announced a potentially unlimited program to buy one- to three-year sovereign bonds from debt-burdened euro-zone governments that agree to an E.U. budget-cutting conditionality program. Draghi called the program “a fully effective backstop to avoid destructive scenarios” for the monetary union. In Japan, the central bank surprised markets and followed the Fed by expanding its asset-purchasing scheme to boost a sagging Japanese economy. “The [Bank of Japan] deemed it necessary to act so that Japan’s economy will not be derailed from a track toward sustainable growth,” bank governor Masaaki Shirakawa said.
Give Ben, Mario and Masaaki credit where it is due: at least they are trying to do something to help the global economy. Markets have cheered their perseverance. Stocks in the U.S. have rallied on Bernanke’s new policy. “Super Mario” Draghi has (yet again) pulled the euro zone back from the brink of disaster. Yields on the bonds issued by the Spanish and Italian governments have plunged, easing the crisis.
Yet this good feeling is unlikely to last for very long. The reality is that central banks cannot on their own solve the problems of the world economy — stamp out unemployment, restore healthy growth or rescue the euro — with the tools available in their toolbox. Not even the bankers themselves believe they can. Bernanke himself admitted that the Fed lacks “tools that are strong enough to solve the unemployment problem.” In Europe, the difficulties facing the monetary union are so deep that Draghi can do little more than smooth them over, not actually resolve them. As Martin Wolf put it:
It is not the ECB’s fault that this action is too little. Its aim is to eliminate the risk of a euro-zone breakup forced by the markets. But it cannot achieve this on its own. Ensuring the survival of the euro zone is a political decision. The ECB can only influence, not determine, the outcome.
Let’s face it — there is just a limit to what monetary policy can do. Easier money from the Fed is not going to reboot the U.S. housing market or convince companies to hire workers they don’t feel they need. That’s because monetary policy works indirectly — by easing, the Fed hopes to make it even cheaper for companies to invest, but that doesn’t mean they will, or that they will hire a lot more people as part of any new investment. Even within the financial sector, which benefits most directly from loose monetary policy, jobs are not being created. Bank of America and other financial institutions have been shedding employees. To truly ensure growth and job creation in the U.S. economy, Bernanke needs help from Washington, in the form of a coherent strategy for reducing the national budget deficit, tax reform and a plan to build better infrastructure and take other steps to bolster American competitiveness. But with American politicians paralyzed by partisanship and locked in electoral battles, no congressional cavalry is likely to appear on the horizon.
Draghi is in a similar position in Europe. A bond-buying program by the ECB can improve market sentiment but it can’t repair the structural problems of the euro zone or fix the finances of member governments. Ensuring the euro’s survival will require tighter coordination of fiscal and banking policies across the euro zone, a real growth strategy, and continued austerity and reform measures on the part of individual governments. Though yields on the bonds of troubled companies have come down since Draghi’s pledge, the underlying conditions in the euro zone have not significantly improved. Greece’s exit from the monetary union is still a real possibility as its government struggles to fulfill budget cuts and other reforms imposed by its neighbors as part of an E.U.-sponsored bailout. Floundering Spain may be moving closer to seeking an E.U. bailout as well. And even as Draghi touted his bond program, he also lowered the ECB’s outlook for the euro-zone economy. The central bank now expects euro-zone GDP to contract by as much as 0.6% in 2012.
Japan’s excruciating experience can tell us a lot about the limitations of central-bank action. The round of easing announced in September by the Bank of Japan is just the latest in a long series of such attempts to stimulate growth since the late 1990s. And where has it all gotten Japan? Not very far. The economy continues to slip in and out of recession. That’s because its politicians have generally failed to undertake the types of reforms — building a better social safety net, bringing down trade barriers and liberalizing the domestic economy — needed to truly return the economy to health.
Even more, central banks are taking on quite a bit of risk by their recent actions. Brazil’s finance chief warned that easing by the world’s major central banks could tip off a “currency war” — a contest to weaken their currencies to spur exports with worldwide consequences. By attempting to aid the balance sheets of European governments, the ECB is potentially creating a hole in its own balance sheet. In an editorial, the Financial Times made that clear:
Mr. Draghi may claim that the ECB will stop buying the bonds of countries which are not compliant with their agreed programs. But doing so after the central bank has stuffed itself with a country’s bonds is like putting a gun to one’s own head and threatening to pull the trigger.
My own opinion is that Ben, Mario and their colleagues have done enough to help the global economy, and that these latest measures are simply cover for a lack of concerted action on the part of politicians in the developed world. Perhaps our central-bank chiefs have again bought us more time. Let’s hope our elected leaders finally take advantage of it.