Quantitative Easing on Turbocharge in Major Economies
In response to the global financial crisis and the muted growth that persists years later, central banks across the globe have aggressively expanded their balance sheets using a range of both traditional and unconventional policy tools. As of the end of June, the combined balance sheets of the U.S. Federal Reserve, European Central Bank and Bank of Japan totaled over $12.1 trillion — a 283% increase since June 2007. Never before have the balance sheets of the central banks of these major economies been so inflated.
The table below summarizes the size and nature of their balance sheets and asset purchase programs.
Uneven Economic Recovery
Although this unprecedented level of stimulus resulted in double-digit asset price returns in the post-crisis period, it seems the markets are experiencing fatigue. Furthermore, asset prices have recovered much more quickly than global economic conditions. Despite the extraordinary efforts by central banks, global growth remains sluggish and inflation is generally running below policy targets. The euro zone is growing at an annualized rate of 1.7%, while Japan’s economy is growing at a pace of 1.9% as of the most recent readings. Inflation in Europe and Japan has, counterintuitively, continued to fall as the size of the quantitative easing programs has increased — in May declining 0.1% and 0.4% year over year, respectively.
It’s for these reasons that Europe and Japan have followed their Nordic counterparts in experimenting with negative deposit rates, although we would argue negative deposit rates are ineffective in achieving their intended goal. Muted growth has not been limited to advanced economies either, as emerging markets growth totaled just 4% in 2015.
Contributing to the subdued growth profile is a loss of momentum in China, the world’s second-largest economy, as the nation’s credit expansion continues to slow. While we don’t expect a hard landing in China, our expectation of sub-7% growth may continue to be a headwind for global growth.
Monetary policy is now experiencing diminishing returns and economic growth is weaker than it should be at this stage of a recovery. With monetary policy experiments — quantitative easing and negative rates — largely exhausted, developed-market policymakers will need to consider other alternatives such as fiscal stimulus in order to generate sustainable growth.
With its recently announced fiscal stimulus package, Japan is the first developed-market country to attempt to pass the baton from monetary to fiscal policymakers in the post-post-crisis period. The country’s recently announced ¥28 trillion (US$277 billion) fiscal stimulus package is equal to nearly 6% of its gross domestic product. Japan, however, has a checkered history of not following through on its announced fiscal plans, and it’s worth noting that only ¥7.5 trillion (US$73 billion) of real spending has actually been approved by Japan’s cabinet as of mid-August.
In the U.S., both presidential candidates have voiced a desire for increased infrastructure spending; income tax cuts and corporate tax reform are additional options that could be used to stimulate growth. While the lack of a central fiscal authority in Europe makes a coordinated effort more difficult, ideas for a fiscal response include infrastructure projects financed by the European Investment Bank, employment subsidies including lower
labor taxes, and education or training subsidies for individuals. Whatever its form, meaningful fiscal stimulus, alongside ongoing accommodative monetary policy, is likely the next stage in attempting to stimulate global growth, as monetary policy alone has not accomplished its original goals.
The success of fiscal reform will depend on how, and how much, fiscal response is implemented. Real structural reforms may ultimately be needed in these countries — especially in Japan, where serious issues related to demographics remain a drag on growth. We view labor market and immigration reform, as well as further integration with the rest of the world through trade, as necessary in Japan. While we believe Europe should focus its efforts on creating a real single-market economy, protectionist actions like the U.K.’s “Brexit” referendum to leave the European Union make a structural solution in Europe more difficult.