The Escape from Balance Sheet Recession and the QE Trap: A Hazardous Road for the World Economy

CHAPTER 2 Monetary Policy and the Quantitative Easing Trap

The discussion thus far has focused on fiscal policy during a balance sheet recession, but the authorities have another tool at their disposal: monetary policy. Economics textbooks tell us the government can manage the economy with a combination of monetary and fiscal policy.

High expectations have been placed on monetary accommodation in the wake of the global financial crisis (GFC) in 2008 and again as the first “arrow” of Abenomics, the colloquial term for the Abe administration's economic policy unveiled in Japan in late 2012. Moreover, many economists seriously believe Japan's recession has lasted as long as it has because of bad policy decisions by the Bank of Japan (BOJ). Their emphasis on monetary policy is due to the fact that for the past 30 years the economics profession has emphasized the primacy of monetary policy over fiscal policy, and since the 1970s most of the policies enacted in response to economic fluctuations in nearly all developed economies have been monetary in nature. This led to high expectations for central banks in Japan and the West during the recent GFC.

The world's central banks responded to those expectations in the wake of the Lehman collapse by taking interest rates to zero or near-zero levels in a record amount of time. They also introduced aggressive quantitative easing (QE) programs. Yet their economies remained depressed. In the United States, the money supply and private credit ...