Has unconventional monetary policy run its course?

Nov 20, 2019

Sections Economics Public Policy

Collections Monetary Policy

Tharman Shanmugaratnam, Senior Minister and Coordinating Minister for Social Policies of Singapore, sat down with Chicago Booth’s Steven J. Davis at the Sixth Asian Monetary Policy Forum, an event organized by Chicago Booth, the National University of Singapore, and the Monetary Authority of Singapore. In a discussion of monetary-, fiscal-, and other public-policy topics, Tharman shared his thoughts on the effects of a prolonged period of very low interest rates and unconventional monetary policies such as quantitative easing, and the international spillovers that may arise.

We’re at the tail end of the global business cycle, but on unprecedented terrain. There’s very little monetary-policy ammunition left for the next downturn, a consequence of the overreliance on monetary policy to date. It’s far from optimal, has undermined the effectiveness of monetary policy itself, and has led to a buildup of financial vulnerabilities. We can’t blame central banks for trying to fulfill their mandate. But we do have to reflect on the governance arrangements and coordination required to achieve a more effective mix of monetary, fiscal and structural policies across the cycle.”

The overreliance on monetary policy has also led to larger spillovers to the rest of the world. That, too, is why the mix of domestic policies matters. What mix of policies in the major economies will enable them to achieve their domestic objectives of inflation, employment, or growth, without the negative spillovers that reduce policy space for other countries?”

If you look at growth since the global financial crisis, two-thirds has come from the developing world. That will likely remain so. A central challenge for the international monetary system must be to help facilitate that growth, and avoid the recurrent disruptions to financial stability that set back that growth.”

There is a broad consensus that the marginal impact of monetary easing on real economic activity is now small and diminishing. But a continuation of extremely easy monetary policy—conventional and unconventional—plus the signals that we give, can lead to continued elevated asset prices and a search for yield, which sets us up for future financial instability.”

We see enough examples of how extremely low or negative real interest rates, and ample liquidity in the system, make financial markets less discriminating between weak and strong firms, and allow zombie firms to live on. It hampers the reallocation of capital and other resources to the more efficient, which has historically been the motive force in productivity growth.”

What has passed as unconventional monetary policy is really quasi-fiscal policy. It has in the main involved maturity transformation within the consolidated government balance sheet, including the central bank’s balance sheet. Treasuries or finance ministries can do that just as well as central banks—in fact, they can do much more of it than central banks, transparently and straightforwardly. So the question is, who takes responsibility for these fiscal actions? And if the central bank takes on such roles over a long period, what happens to its independence? It is ultimately a matter of political judgment as to which fiscal instruments we should use to deliver a stimulus, bearing in mind especially that they each have distributional consequences. So my instinct is that it’s better for central banks not to stay there for too long.”

We also have to think hard about how we sustain an active fiscal-policy role going forward, but with a discipline that has not been common in fiscal policy globally—being able to roll out projects quickly, without long lags, when the economic cycle demands, and knowing when to pull back spending in good times, so that government debt does not move up endlessly. It requires a new political economy.”