“We’ve had six or seven years of this and we still have a weak recovery. So you have to ask ‘is this the answer?'” Such are the words of the Governor of the Reserve Bank of India, Mr Rajan, commenting on the effectiveness of Quantitative Easing.
Before taking the reins at the RBI last year, Mr Rajan was an economics professor at the University of Chicago. This sets him apart from just about every Central Bank Governor in the world today. Chicago economists are brutally frank when it comes to questions of interventionist economic policy. They are not against it in principle, they just need evidence that it works in order to support it. Mr Rajan, quite correctly, has decided to publicly challenge the growing chorus of QE supporters around the world without the slightest evidence of success.
So what happens next? If QE has been an ineffective policy for the last six or seven years, withdrawing from QE is likely to be just as ineffective for the next six or seven years. The Federal Reserve will start raising rates some time next year with no predictable consequences. Mr Rajan’s point is that its time for a fundamental rethink about the conduct of monetary policy. But the real economy is unlikely to provide Central Bankers with the breathing room to extricate themselves from their policy mess.
This is because the Real Business Cycle is trundling along, as it has done for hundreds of years (recession, recovery, boom and bust). These cyclic components last for five to eight years on average – so by this metric the US expansion, weak as it has been, must soon be drawing to a close…
…which means that the Fed will be seen tightening policy into a recession. What do they do then? Its back to QE, I suppose, the New Normal in monetary policy!