The aftermath of the financial crisis has been the era of the central banks. Never before have our supposedly infallible monetary overlords been charged with so much responsibility for our collective welfare, and never before have they responded with anything nearly as radical and on anything near the same scale as the now seemingly conventional policies of ZIRP (Zero Interest Rate Policy) and QE (Quantitative Easing).
The Bank of Japan were the first to try their hand at QE, and in ever larger doses as recovery remained elusive. The lack of tangible results never gave pause to reflect on the merit of the policies pursued. Lack of economic growth has always been interpreted as only meaning one thing: the medicine is not strong enough. After decades of meagre results, negative interest rates were introduced earlier this year. Again seeing no tangible results, and clearly running out of patience, the latest move is direct yield targeting on the 10-year JGB, another first.
The ECB has not been shy in following where the BoJ has lead the way. Loading the balance sheet up with anything from dodgy Greek government debt to corporate bonds, the ECB has become the buyer of last resort in European fixed income markets. It is well known that our own Bank of England and the US Federal Reserve have not been shy either in pursuing large scale QE to accompany rock bottom policy rates.
But increasingly, the central banks are not the only game in town. Severely indebted governments have been reluctant to throw the weight of fiscal policy behind the monetary extravaganza, as they have been sitting on the side lines hoping their friends in the central banks would solve the problem of recovery for them. Almost a decade on from the financial crisis, is seems clear to most that they are not up to the task. So calls are being heard from many corners that it is time for government to step up to the plate. With borrowing costs at all-time lows, it is time to borrow and spend. Expansionary fiscal policy, mainly infrastructure spending, will surely be the missing piece to the recovery puzzle. And governments all over the developed world, wrestling with unhappy electorates being tempted by the fringes of politics, are increasingly happy to heed the call.
This is the Keynesian consensus, and it works equivalently to a pyramid scheme: it prescribes that lack of economic recovery is met with more of the same or even more radical policies. It is a game they cannot lose. Recovery will vindicate them. The much more likely outcome of continued stagnation is seen as proof that the policies have been necessary, but not radical enough. Witness the BoE’s response to the Brexit vote. An immediate 25bp cut to the base rate will, in the case of Brexit leading to a crisis, be seen as a sly pre-emptive move. In the case of no crisis, the medicine worked as intended. All hail the BoE. Heads, they win, tails, you lose.
This is the game the institutions of government have been playing for years and, in the case of Japan, for decades. There is only one outcome that can break the consensus and with it the choke-hold in which these institutions are holding the global economy: recession, even larger and more broad-based than the last (possibly sparked by runaway inflation and an inevitable hike in interest rates). Until it happens, the Keynesian consensus is bound to lead us down a road of ever larger, ever more radical, and inevitably futile policy responses.