Is Monetary Policy Dead?

Last week I presented my views on Quantitative Easing and Tapering at the AsiaMoney Borrowers and Investors’ conference in Singapore. Basically, I pointed out that almost all the monetary injection that had been provided by the US Federal Reserve had found its way back to the Fed because consumers and investors did not want to spend the additional liquidity. By this analysis, the Fed’s QE policy had failed and future tapering is much more difficult than most markets participants can comprehend. (The presentation can be downloaded from our website at Velocity presentation)

I had expected that many in the audience would not understand what I was saying since it is very different to the mainstream view expressed in the popular press. To my great satisfaction, however, the feedback was that my point was “… very clear and very succinct…”. Moreover, several delegates asked me what role, if any, does the Fed have to play if the conditions for an effective monetary policy are violated?

This is the $64,000 question. I was impressed that at least five delegates asked me this question but also astonished that hitherto they had believed that the Fed could systematically influence economic activity in the textbook fashion. (My cynicism towards active monetary policy is clearly not the common belief!) So, what is the answer?

In short, monetary policy is dead. The days when a Central Bank could independently increase the money supply and expect either output or prices to rise have gone. People simply don’t need paper money to purchase goods or services any more. (A central plank in monetary theory is that all purchases are made with paper money, and this assumption provides the path for active policy). The QE experience, however, demonstrates that this is rubbish since the additional paper that the Fed has printed has been given back.

Personally, I can live comfortably aware that Central Banks’ monetary policy tools are very blunt. Some market participants, however, feel uneasy when they discover that monetary policy doesn’t matter any more. Central Bankers seem blissfully in denial of the evidence, but this is not surprising since otherwise they would be out of a job!

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