Key points about monetary policy

• Governments have relied on monetary policy starting in 1987, with Alan Greenspan as Chairman of the Board of Governors at the Federal Reserve. It became the instrument of choice for all kinds of crises.
• But monetary policy has become increasingly ineffective in promoting real economic growth. Every crisis was met with monetary easing that caused debt and other imbalances to accumulate over time, and that caused the next crisis to be bigger than the previous one. The next crisis then needed more of a punch from central banks. However, since interest rates were never raised as much in upturns as they were lowered in downturns, the capacity to deliver that punch was decreasing.
• It’s true, the Fed had no choice but to step in to prevent a financial meltdown (in March 2020). But this meltdown only happened because of the monetary policy instituted over previous years.
• You see, by keeping interest rates too low as a means of stimulating economic growth, central banks are inducing corporations and households to take on more debt. 
• To a large extent, this debt is not used for productive investments, but for consumption or, especially in the U.S., for the buyback of shares. 
• This creates a debt trap, as well as increasing instabilities in the financial system. These instabilities broke out in March, and the Fed responded adeptly to stop the panic. But the point is: Central banks create the instabilities, then they have to save the system during the crisis, and by doing so they create even more instabilities. They keep shooting themselves in the foot.
• Governments should use the current environment to borrow long and lock in cheap money while they can.
• This is not the time for austerity due to the pandemic crisis, but governments should set clear guidelines about how they intend to get debt levels down in the future. They should reevaluate budgets and use of funds, e.g., cut subsidies that often go to special interest groups that don’t deserve them.

Asked if central banks have reached the end of the road, Bill replied:

• Just read what Bill Dudley, the former president of the New York Fed, wrote in Bloomberg a couple of weeks ago. He warns that central banks have run out of firepower, and that the side effects are getting worse. I agree with every word. That is the most dangerous effect of the past 30 years of monetary policy: Debt levels have constantly been building up, and so have the instabilities in the financial system.
• This is exactly my definition of the debt trap: Central banks know they can’t leave interest rates as low as they are, because they are inducing still more bad debt and bad behavior. But they can’t raise rates, because then they would trigger the very crisis they are trying to avoid. There is no way out but to keep doing what you are doing, but by doing that, you are making it worse.
• In 2008, the ratio of global household, corporate and government debt-to-GDP was 280%. Early 2020, this ratio had grown to 330%. And it’s not just the quantity of that debt, it’s the quality.
• Most of the new corporate debt is BBB-rated, covenant-light, low-quality stuff. The reason for that is the ultra-easy monetary policy we have seen post-2008.
• Governments made the mistake of embracing fiscal austerity too early. By doing that, they made it the job of the central banks to frantically try to create economic growth. This is a mistake we must avoid after this crisis. Fiscal policy will have to play a much larger part going forward.
• There is no return back to any form of normalcy without dealing with the debt overhang. This is the elephant in the room. If we agree that the policy of the past 30 years has created an ever-growing mountain of debt and ever-rising instabilities in the system, then we need to deal with that

The full post containing more gems is here:

https://www.cmgwealth.com/ri/on-my-radar-what-do-we-do-now/

Anything complex you want me to explain in order to understand come and see me.