After the 2008-09 financial crisis, major central banks undertook a giant monetary policy experiment to see whether quantitative easing or its variants could restart the world's economic engines. As much of the world keeps pumping money into its various financial systems, however, the U.S. Federal Reserve is moving in the opposite direction by raising interest rates. On Friday, all eyes at the annual central bankers' symposium will be on Federal Reserve Board Chair Janet Yellen to see whether her speech will give any indication of the Fed's next interest rate hike. Throughout the conference, which kicked off Thursday in Jackson Hole, Wyoming, the disputed success of quantitative easing will be a topic of much discussion.
The global quantitative easing experiment sent balance sheets soaring at the world's central banks; the Fed's grew from roughly $800 billion in 2008 to roughly $4.5 trillion today through purchases of assets such as bonds. Since dropping its own expansionist policy in 2014, the Fed has been in the process of tightening markets, and in December 2015, it began to raise interest rates. The results have been largely positive. U.S. unemployment has been cut in half since peaking at 10 percent in 2009. Economic growth has also gotten back on track, though its recovery has been choppy at times. It is unclear to what extent Fed policy caused the comeback, but regardless, the U.S. economy is relatively strong today.
That is more than the rest of the world can say. To encourage growth, the Bank of Japan and European Central Bank (ECB) keep pouring money into their respective systems, to little avail. Still, the Bank of Japan is likely to expand rather than curtail its quantitative easing program, which has no set end date, perhaps at its next monetary policy meeting in September. Though the ECB's program is scheduled to stop in March 2017, the bank will probably decide to extend it again. After renouncing its asset purchase program a few years ago, the Bank of England was forced to resume it in August to counter the market volatility that followed the Brexit vote. None of these plans were designed to be permanent solutions, and their influence over market dynamics is diminishing. The Bank of Japan's asset purchase program, for example, has not prevented the yen from appreciating by roughly 16 percent against the dollar this year.
Moreover, the plans have structural limitations. The Bank of Japan already owns 38 to 45 percent of Japanese government bonds with a maturity of less than 10 years, along with a quarter of government bonds with longer maturities. Those figures are well shy of 100 percent, but they are nearing their limit. Many investors that hold bonds with longer maturities, such as pension funds or insurance companies, are reluctant to part with their bonds since they value their stability and do not want to reinvest in a market with lower interest rates. This problem is not unique to the Bank of Japan. When it restarted its asset-buying program, the Bank of England fell short of acquiring its desired 1.17 billion pounds ($1.55 billion) in gilts with a maturity of over 15 years in a reverse auction. To make matters worse, since many of these central banks have been purchasing shorter-term bonds whose maturity dates are now swiftly approaching, they may have to buy even more bonds to hit their targeted rates for expanding their bond holdings.
For Japan's central bank, this may mean it is time to taper or otherwise adjust the program while looking for a more sustainable solution. The bank has several possibilities to choose from. Pushing interest rates even deeper into the negative territory is one option, albeit an unpopular one. Issuing helicopter money, which would entail the central bank underwriting the Japanese government's fiscal expansion, is another. But no developed country has tried helicopter money since World War II. Before the war, Japan did so and experienced hyperinflation as a result.
Given the uncertainty surrounding the Brexit negotiations, the ECB and Bank of England's cases are perhaps even more complicated. The United Kingdom's decision to withdraw from the European Union highlights the convoluted political decision that the ECB faces: As a patchwork of different economies with different challenges, the eurozone presents an unusual challenge for the ECB, which must try to prescribe policies that will suit them all.
Prior to the Brexit, the United States and United Kingdom had the fewest structural problems and risks. The United States does not face the same demographic crunch that the rest of the developed world is feeling, and fractious as it may be, the U.S. government is far more organized than the hodgepodge that exists in Europe. Keeping its own currency has shielded the United Kingdom from many of the eurozone's problems (though, of course, the Brexit could disrupt its stability). Japan and the eurozone, by contrast, have economies with so many structural challenges that they need a drastic political solution to fix them. The problem for these economies is that as their tools dull, central banks have to find new ones that are less effective or more politically controversial. In the next five years, they will probably have to change course yet again. And the impacts of the new strategies will not be confined to the countries adopting them. Since these economies form the basis of the global financial system, one country's problem is every country's problem.
No matter what kind of program the world's central banks resort to next, the reality is that monetary policy can do only so much to solve economic crisis. An economy's underlying structure is far more important, and no amount of quantitative easing can fix structural problems.