Monetary moves have lost their magic

September 22, 2011

By Edward Hadas
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Financial markets are tiring of the Federal Reserve’s love offerings. The U.S. central bank has long been able to soothe nervous investors with rate cuts or newly-printed money. But markets spurned Wednesday’s announcement of the Twist, an operation to lengthen the maturity of $400 billion of the Fed’s $1.7 trillion U.S. Treasury.

Stock markets fell sharply and the price of bonds from governments still considered safe rose. Investors were right not to be impressed. The Twist is aimed primarily at the U.S. housing market. But even if the Fed’s rearrangement lowers mortgages costs, house prices will be held back by a weak economy and the massive oversupply left over from the bubble years.

Tight monetary policy has long ceased to stand in the way of economic growth. Official real interest rates are solidly negative almost everywhere. The Twist could even impede lending –- and growth –- by narrowing the gap between short and long term rates. Banks, after all, gain from a steep yield curve.

Central banks could try to regain investors’ favour with yet more monetary love. The Bank of England dropped some not so subtle hints on Sept. 21 about another round of quantitative easing. There are calls in the United States for QE3. But no amount of money –- whether it comes from fiscal transfers, QE3 or QE33 -– can force banks to lend or consumers to borrow and spend.

More money will not push up the prices of financial assets which investors deem too risky. The Asian market rout is caused in part by fund managers trying to get ahead of an expected wave of redemptions from cross-border investors. But while the gains from monetary stimulus are small, the potential harm is significant. The Fed and its peers are creating piles of money which would be put in and taken out of different assets in disruptive quantities and dizzying speeds.

In the current economic environment, the twists and turns of monetary policy will not reduce unemployment or rebalance trade. It would be better for the world if central banks stopped trying.


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One thing you missed. Investors do not run a punch press in a factory, unload a ship, drive a truck, or teach school. They work for a living, and all the money grabbers are trying to take what little they have. They are rebelling from being jailed in an endless labyrith of fees and interest rate hikes on credit cards and mortgages. Nobody asks them how to fix this mess, including this journalist, who thinks he knows how it works.

Posted by fred5407 | Report as abusive

It would be even better if also politicians would stop spending beyond their means. Adding debt seems to be impopulair these days.

Posted by FBreughel1 | Report as abusive

Good piece, Mr. H. But I’m not so sure the central banks should stop trying before the politicians start.

Posted by PCScipio | Report as abusive

Given your macro-economic expertise and background, can you share your thoughts on what will help with the current condition and how it will play out over time?

Posted by Mott | Report as abusive

Exactly. In fact, one might wonder whether any mortgage lender would be remotely interested in locking itself into a 30-year obligation at a historically low rate. If that lender believes, in fact, that a recovery and adjustment will occur, it would be irrational to take 3% now if 6% or 8% is possible in five years.

As to the printing of money, I commend you for going as far as you did, but you predictably did not go far enough. But you know the refrain. If the central banks actually do quit printing at this point, all it will do is lessen the devolution and coming hyper-inflation in a fractional measure. Maybe we get 9,000% inflation, rather than 10,000%.


Posted by BowMtnSpirit | Report as abusive