To explain this observation, we must look back to the Great Recession of 2008-2009. Among other factors, the crisis was caused by excessive household debt in some countries, housing market speculation, and high-leverage financing mechanisms. It resulted in massive job losses, the structural tightening of the financial sector regulatory environment, a public finance crisis in the eurozone, and a strong tendency towards disinflation. This list is not exhaustive, but it explains why classic monetary policy (rate cuts) did not have the intended impact. We have thus witnessed the launch of an unconventional policy (printing money) worldwide, given that it was adopted in the US, the UK and Japan, and that it was just introduced in the eurozone.
The real challenge today consists in evaluating when and to what extent this unconventional monetary policy will have an impact on economic growth and inflation, especially since the previous links between monetary policy decisions and their impact on the economy (the “multiplier effect”, as economists like to say) are no longer reliable. The same problem arises when analysing the consequences of the decline in the euro or in oil prices. In the past, a USD10 decline in oil prices stimulated eurozone growth by 0.4%. Considering that there was an even greater drop in oil prices in 2014, even after taking the euro’s decline into account, by how much should this figure be multiplied? The same question applies to the euro’s depreciation: this usually has a 0.7% impact on GDP after one year, but where do things stand today? To return to our metaphor, when driving a car on ice, it is hard to manage the relationship between the accelerator and the speed at which the tires are spinning.
For the ECB, the risk of underestimating the impact created by the different impulses (monetary policy, currency, oil prices) is not a problem. On the contrary, having to raise its forecasts would be a small price to pay for confirmation of its monetary policy’s effectiveness. For the Federal Reserve, the stakes are much greater: should it hit the brakes in advance, or can it wait until inflation exceeds its target before acting? Based on recent declarations, it looks like the Fed will hold off as long as possible. Ultimately, it is investors who have the hardest task: with long-term rates at extremely low levels, reactions to good or bad news will come extremely fast – which means investment managers will need tremendous driving skills.
