The power of monetary policy in 4 charts

The monetary policy responses of Japan and the Eurozone to weak inflation couldn't be more different.

Deflation risks

At a dovish extreme, you have the Bank of Japan respondingly aggressively to deflation. 2013 saw newly installed central banker Haruhiko Kuroda steer the economy from deflation to inflation in excess of one per cent.

While the same year saw the European Central Bank (ECB) preach "accommodative" monetary policy, yet inflation trended lower in the currency bloc. Demand in the Eurozone has crumbled without adequate monetary support.

Ben Southwood, head of macro policy at the Adam Smith Institute, says that ECB president Mario Draghi and his colleagues are "asleep at the wheel".

"It is flabbergasting that they are letting inflation fall so far below their target that some members of the Eurozone are seeing deflation," says Southwood.

The gap between inflation in Japan and the Eurozone is now at its widest in 16 years.

Correct policy?

Southwood says that every major macroeconomist recommends that "central banks should be erring on the upside, overshooting inflation to cushion demand, rather than guaranteeing perma-stagnation with contractionary tight policy."

A recent IGM Forum poll found that 78 per cent of economists agree that we'll be looking back on the US Fed's initial round of quantitative easing as a success.

We can look to the Taylor Rule - a monetary policy rule that compares inflation and actual GDP with potential GDP - for an evaluation of how tight policy should be.

Last November, Societe Generale's Kit Juckes crunched the numbers.

As you might expect, the analysis suggests that the European Central Bank is keeping policy much too tight. Refi rates should be at minus two per cent.

Juckes says that "falling inflation and rising unemployment justify MUCH easier ECB policy."

What might be surprising is that the Taylor Rule suggests that the dovish Bank of Japan has the potential to go further still.

Juckes says "the message is that the current strategy is working but rates are still too high and more effort is needed. More QE please".