The latest decision from the European Central Bank to reactivate quantitative easing to revitalise the comatose Eurozone economy has been met with scepticism — this time even by central bankers in the Eurozone.
The doubters within the central banking community are now openly voicing their disagreement with such monetary policy tools.
Monetary policy in the US and the UK too is ever more widely critiqued for being ineffective and for causing inequality and asset bubbles. Low interest rates and cash injections into the financial system are not translating into significant private sector investments and well-paid employment.
Rather, cheap central bank money ends up in financial markets and real estate, increasing the wealth of those who own shares, bonds and property.
Consequently, the wealth inequality in the US and Europe is reaching worrying levels, fuelling the rise of populist parties with policies that are economically protectionist and socially reactionary.
To give central bankers some credit, their interventions succeeded in preventing a meltdown of financial markets and collapse of national and global economies when the historically huge banking crisis in the US and then the sovereign debt crisis in the Eurozone erupted a decade ago.
However, continuing with measures that had worked to prevent a financial disaster in order to achieve a sound economic recovery and sustainable growth is a mistake — and one that now even central bankers themselves belatedly seem to admit.
The main reason that these kinds of policies do not work is that the economic models on which they are based fail to accurately reflect today’s unruly and complex financial system.
Central bank models assume the unproblematic flow of funds from the financial system to a real economy, guided by profit seeking and increased productivity through long-term investments. This is no longer true in a financialised economy where the pursuit of short-term speculative gains in financial markets blocks the flow of money into job-creating productive investments in the real economy.
We now have a financial sector where the primary goal is to search for high yields without considering the consequences of bubbles in the market. When these bubbles burst (as they have been doing since the late 1980s everywhere from emerging markets to the US and Europe), there are significant economic and social costs — such as fiscal deficits, low wages, unemployment, and productivity losses.
The shareholder primacy of the corporate world incentivises executives to use resources to maximise share prices, at the expense of paying high wages and increasing investments. The profits generated are often spent on stock buybacks, high dividends, and M&A activity — because this is the way to drive stock market value. Executives tend to have remuneration packages that are linked to the share prices of the companies they manage.
Central bank economic models fail to reflect this real-world behaviour. And that needs to be addressed, for the sake of our economic future.
As more and more chief executives, fund managers, and politicians begin to argue that the short-termist shareholder value model should be replaced by long-term societal and environmental goals, we need to combine a coordinated monetary and fiscal policy with reform of capital markets.
Monetary and fiscal policies cannot produce investment-led sustainable growth without capital market reform. To that end, a new public institution with democratic accountability should be created that coordinates monetary and fiscal policies, as well as overseeing such reforms.
Endless central bank activism without radical reform of the financial system and the governance of monetary and fiscal policy will never produce the results that we desperately need.
Ismail Ertürk is speaking at the Radix conference “What Next for Monetary Policy” on 27 November.
Main image credit: Getty