Global central banks are embarking on fresh waves of bond-buying to fight the fallout from the coronavirus pandemic, despite mounting claims that the once-mighty policy is losing its power to boost the economy.
The U.S. Federal Reserve, Bank of England, Bank of Japan and the European Central Bank have splurged $5.6 trillion this year alone on quantitative easing, according to Bloomberg Economics. The ECB is expected to increase its own purchase plans by as much as €500 billion ($605 billion) when it meets Thursday.
Central banks' own research departments regularly produce work showing quantitative easing has stabilized markets, boosted growth and driven faster inflation. Outside though, there's far less certainty that those benefits will persist after years of monetary stimulus following the global financial crisis more than a decade ago.
"QE works particularly well during periods of market disturbances, but it won't be able to do much at this point for growth and inflation in the absence of fiscal policy," said Peter Praet, former ECB chief economist and an architect of Europe's own large-scale bond-buying plan that began in 2015.
Massive purchases of public and private debt pump money into the financial system with the aim of lowering the rate of interest on assets. With their traditional tool of official rates now close to or below zero, quantitative easing has become the primary stimulus tool for many central bankers.
Recent work by Stanford Institute for Economic Policy Research economist Ramin Toloui argues that quantitative easing has been effective in lowering bond yields and it has "reshaped market expectations of how the Fed would behave in the future."
Still, the further bond yields drop, the greater the risk of unintended consequences. If the aggressive monetary policy of the past years has run its course, it may be harmful to continue relying on it.
Former U.S. Treasury secretary Lawrence H. Summers and former Council of Economic Advisers chair Jason Furman wrote in a Nov. 30 paper that much more robust action by finance ministries is needed instead.
"How much investment would be done at a 0% 10-year Treasury rate that would not be done at a 1% 10-year Treasury rate," they wrote in the Brookings Institution article. "The consequence, if not compensated for by more active fiscal policy, would be longer and more severe recessions."
Another central function of quantitative easing, encouraging investors to take riskier bets, is losing its potency. Depressed yields have spread to assets with ever-longer maturities — further along the yield curve. That weakens the link between risk and reward.
The Bank of Japan has long been a trailblazer for quantitative easing. But even after piling up assets larger in scale than the size of its entire economy, it has failed to generate the stable inflation it sought. Its switch to yield-curve control in 2016 was in part a recognition that it had to adjust its approach to stop yields falling too low.
That's an issue Europe is now grappling with. Joseph Gagnon, an economist at the Peterson Institute for International Economics in Washington, said the ECB is essentially "out of room" for quantitative easing. All of of Germany's sovereign debt — typically considered the region's safest asset — has a yield below zero, meaning investors lose money by holding it.
"There's a lower bound to quantitative easing, just as there is a lower bound for ordinary policy," he said.
Bank of England policymaker Michael Saunders voiced a similar concern recently when he said that in the U.K., "further asset purchases by themselves may be less effective in providing additional stimulus" without an interest-rate cut. The BOE's benchmark interest rate is currently 0.1% and policymakers are mulling whether to take that below zero.
Unsurprisingly, central banks' own research departments have typically argued for quantitative easing's previous effectiveness, work that provides the backdrop to today's policy debates.
