A Financial Times Special Report and Some Thoughts on the Ineffectiveness of Monetary Policy

Let me start this by saying that I am reluctant to post about monetary policy. I read Florian’s posts with great interest and some reverence, due to his enormous knowledge on the issue. However, at the moment there is an interesting special report series going on in the Financial Times Video section. John Authers is interviewing a number of interesting people and showing different charts that support his hypothesis that the current US “recovery” is the direct result of monetary policy and, more importantly, completely unstable. I found his figures so interesting, that I decided to share them with you. Unfortunately the ft content is restricted to subscribers (you could get a four weeks for 4€ digital test-subscription though), which is why I’ll give you a brief summary of what he is showing. [Edit: I just saw that the ft has made the videos available on youtube. I added the links below]

In his first video  (Youtube Link) “Is US stocks’ recovery sustainable?” we are shown a number of charts. Earnings growth for the S&P500 companies has flattened out after 2011 even though stock prices have continued to grow. If this signalled indeed a recovery of the real economy, it should be accompanied by rising consumer price inflation. This hasn’t been the case however, even though raising inflation has been the goal of the FED all along. So, we are more than justified in asking, whether the recovery is real? I do like graphs, and it seems that John Authers does too, and the two lines in the graph below, depicting the S&P 500 Index and the FED’s balance sheet as a proxy for its QE programs move together so closely that it is quite startling.


In his second video (Youtube Link) John Auther is interviewing Tim Lee of Pi Economics regarding the sustainability of US after-tax corporate profits. These profits are currently 10% of GDP which is the highest level since WWII (the long-run average is 6% and the share tends to reverts to the average). Tim Lee explains that this is mostly the result of excess debt and leverage on the corporate level, which is driven by the current FED policies. The following chart shows the level of leverage adjusted for the variation in profit shares (as a deviation from the long-run mean). Clearly, around 2000 a severe decoupling of the treasury yield and leverage ratio has taken place, which has become even worse after the financial crisis. This situation has become so unstable, that in the view of Mr. Lee it could implode any moment even if the FED continued it’s QE program.


I said I was going to post about development economics, but I’ve made an exception today, due to one simple reason: Since the start of the crisis there has been one thought on my mind: So, we build up a bubble by not taking into account asset prices when we do monetary policy and by lowering interest rates when we face an economic shock, instead of thinking about structural/ real adjustments1 and THEN, when that bubble bursts, we attempt to cure the economy with more of the some nonsense?!? Am I really the only one who thinks that this is madness?2

Anyway, until last week I had trouble articulating some of my thoughts on the matter. However, I think I am now capable of articulating at least some of the main themes of why I think that monetary policy is at the moment ineffective in raising core inflation, why we should not expect monetary policy to lift us out of a deeply structural crisis like the one we are in and why the way MP is conducted at the moment is actually potentially very harmful, because the problems it creates are only getting larger and larger over time. So, POSSIBLY, if I find time, I’ll tell you my thoughts on that matter.


1Think about it as a Taleb (the Black Swan guy) argument: we oppress the small fluctuations rendering our system more and more vulnerable in the process.

2There are maybe three things that I should address right here and now: Firstly, I do not think that monetary policy is generally ineffective, just at the moment and given our goals and that is definitely our fault. Secondly, I acknowledge that at the beginning of the crisis, monetary policy needed to be the way it was to mitigate the initial liquidity shocks and acting as a lender of last resort (policy lessons from the 1930s). Thirdly, of course, there is always the argument that “but, oh my god, what would have happened if we hadn’t done it; Great Depression, End of the Eurozone, etc.etc.”, but, well, right now there’s really no way of telling, is there?


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