21 January 2015

Monetary Policy: the great illusion


Since the European Court of Justice has extended the mandate of the European Central Bank, it will be allowed to start a programme of quantitative easing. Economists and pundits are celebrating what the left wing medias in Europe have dubbed as a “victory” for monetary policy. It remains to be demonstrated whether an active monetary policy will drag the Eurozone out of its current stagnation. The supposed efficiency  of the quantitative easing policy, injecting new money into the economy via the banking system, is, according to its supporters, to be found in the US recovery. However, coincidence  in Economics, as in any other science, cannot be accepted as a proof. The US Federal Bank monetary policy may or may not be the cause of the current impressive American rebound. Maybe, and most probably, entrepreneurship, innovation, the “animal spirit” of the Americans are the true reasons why America is back. It also remains to be verified to whether or not this abundance of  cheap money, originated by the Federal Central Bank, has been invested mostly  in speculative funds. If this were the case,  when interest rates inevitably rise, quantitative easing could be revealed in a couple of years as a time bomb ready to explode, leading to a new financial crisis, comparable to 2008.

We thus wonder why monetary policy, like budget deficit interventions, are so highly praised by political leaders, media pundits and media savvy economists. This love for intervention probably has nothing to do with Economics as a science. Government or central bank interventions as a theoretical  incentive  for growth are seductive for the media and for the public opinion: it is news, it is action. Monetary policy, in Europe, makes headlines. For political leaders as well,  this kind of acting brings them to the forefront of public attention: they give the illusion that they are the masters of the game, that economic growth obeys their orders. Following this political discourse, markets fail while governments and central banks pretend to be the saviours of the economy. If this was really the case, one wonders why all governments do not intervene more systematically to promote growth, but do so only erratically. If we remember a not so distant past, the Soviet and the Chinese governments used to announce the growth rate for the year to come on January first. At the end of the year, statistics were manipulated to show that the economy reached the announced target, until the day when it was revealed that this command economy existed on paper only. The current enthusiasm for active monetary policies (since budgetary policies and lower interest rates failed to awaken the Eurozone) is a remnant of the command economic illusion. The truth is that the economy never follows mechanical instructions from political leaders or bankers. As Hayek explained, the economy is too complex, and becoming more so, to be mastered from the top. Most probably, economic policies in general play a very limited role in economic growth. We know that government errors can destroy growth through inflation, regulations, taxation, protectionnism, confiscation of private property. On the other hand, we do not know to what extent economic policies can incentivise growth. If we did know, all countries would be growing at a fast clip.

If we compare, as previously mentioned,  the growth rates in the US and in Europe now, to think that monetary policy explains the gap would be preposterous. Regretfully for political leaders and media pundits, economic growth is a more complicated and very slow process. Today, there is a consensus among development economists that the quality of public institutions (rule of law, transparency, respect of contracts and private property) is the real cornerstone of development. Institutions cannot be created overnight; they could only be destroyed on a whim. These are the reasons why we predict that quantitative easing in the Eurozone will have no positive impact on growth. Moreover, quantitative easing does not address the real issues which are a brake on growth and generate unemployment all over the continent: the labour market’s excessive regulations are the major cause of joblessness, as a comparison between European countries clearly show (France, Italy, Spain are the most heavily regulated, and have the highest unemployment rate). Another comparison between the labour market in the US and in Europe also confirms the direct relationship between over-regulation and unemployment. Monetary policies do not deal with these actual discrepancies. This is another reason why quantitative easing is popular: it gives the illusion to act without really acting, but skirting the tough issues.

Guy Sorman is an economist at the University of Paris and author of many books on classical liberalism including: The American Heart, In Praise of Giving, 2014. He is also publisher of France Amerique and founder of Action against Hunger.