Everywhere one looks across the developed world, central bankers are taking increasingly unorthodox actions to buy more time for politicians to put their fiscal affairs in order. Mario Draghi, president of the European Central Bank, at last brought a “big bazooka” to his shoulder in defence of the eurozone by pledging to backstop weaker members’ debt. Ben Bernanke, chair of the U.S. Federal Reserve, revealed the Fed will go on buying financial assets until America’s economy recovers. The Bank of England and the Bank of Japan have their own aggressive bond-buying programs. Yet politicians are showing little inclination to seize this opportunity.
The latest announcements represent a continuation of so-called unconventional monetary measures first taken during the 2008–09 financial crisis. Central bankers across the developed world quickly exhausted their traditional instrument, which is lowering overnight lending rates. When that did not prompt enduring recovery, they resorted to methods such as “quantitative easing.” QE (as it’s known in shorthand) involves the central bank’s buying financial assets like government bonds. The theory is that these purchases lower long-term interest rates, thus encouraging businesses and consumers to spend. The Fed has already engaged in two rounds of QE, buying massive quantities of U.S. Treasury bills and mortgage-backed securities.
The latest initiative, dubbed QE3, involves buying US$40 billion of mortgage-backed securities every month indefinitely and extends earlier asset-buying programs. The Fed claims this “should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”
Draghi is doing something similar, for different reasons. Earlier this year, countries on Europe’s periphery (notably Italy and Spain) faced rising interest rates on newly issued government bonds, which threatened to push them into insolvency. Since central banks can theoretically create unlimited quantities of money, the ECB could buy virtually all bonds issued by afflicted governments. By threatening to do this, the ECB hopes to assuage the fears of other bond investors, thus keeping borrowing costs low. So far, it seems to be working. Since Draghi first hinted his intentions this summer—he famously said the ECB “is ready to do whatever it takes”—Italian and Spanish bond yields have fallen markedly.
Considered together, these monetary policies are historically unprecedented. “Even during the Great Depression of the 1930s, policy rates and longer-term rates in the most affected countries (like the U.S.) were never reduced to such low levels,” wrote William White, chairman of the Economic Development and Review Committee at the OECD in Paris, in a recent paper. Yet many expect the impact of the latest tactics to be transitory. Draghi’s bazooka “is not a game changer,” opined economist Nouriel Roubini. “It only buys time for policy-makers to implement the tough measures needed to resolve the crisis.” Likewise, QE3 affords more breathing room to Washington policy-makers preoccupied with election posturing.
Bernanke himself has said it’s crucial “that fiscal policy-makers put in place a credible plan that sets the federal budget on a sustainable trajectory.” Governments, in other words, must make the unpopular but necessary cuts now to finally lift the pall of fear surrounding a possible greater reckoning to come. Progress in that regard is hardly encouraging.