Several signs suggest loose monetary policy is increasingly proving ineffective, and central banks are failing to generate enough cyclical upswing to win against the structural forces constraining growth and inflation. Monetary stimulus alone cannot fix debt overhangs, low productivity, persistent unemployment, stagnant demographics and a lack of reforms and fiscal stimulus.
In the US and UK, where quantitative easing is deemed most successful and interest rates are expected to be lifted sooner than anywhere else, wage growth remains weak despite rising GDP growth and falling unemployment. Companies and households, which reduced excess debt during the crisis, are starting to borrow again. Nearly a quarter of mortgage borrowers in Britain are taking on loans of four times their gross income, despite the red flags raised by the Bank of England. In both countries the recovery appears deeply uneven, as financial centres like London or New York pull further ahead of other areas.
The eurozone faces more complex challenges. The rebound generated by the European Central Bank’s QE programme in the first quarter is losing momentum and inflation expectations are almost back to where they were before QE was announced.
The transmission of credit to small and medium-sized firms remains impaired. Banks are still deleveraging, and with €1tn of non-performing loans on their balance sheets, or more than 10 per cent of GDP, they are hardly able to lend.
The good news is that policymakers are moving in the right direction by cleaning up banks, harmonising regulation and deepening capital markets. But this will take years. Meanwhile, fiscal stimulus remains insufficient and the Juncker plan for investment is still in its infancy.
Banks that were cleaned up and recapitalised are now seeing bad debts rising again, as property prices keep falling in peripheral cities. While authorities still have dry powder available to soften the landing, a failure to reduce excess industrial capacity and address debt overhangs may result in deflationary pressures and larger economic losses down the road.
A prolonged loop of loose policy carries dangerous side-effects for the economy and for society: potential asset bubbles, over-allocation of resources to leverage-heavy industries and rising inequality. Central bankers increasingly appear to be parading in the emperor’s new clothes.
Alberto Gallo is head of macro credit research at RBS