William White: Ultra easy monetary policy and the law of unintended consequences

In a must read article, economist William White evaluates

the desirability of ultra easy monetary policy by weighing up the balance of the desirable short run effects and the undesirable longer run effects – the unintended consequences.... 

He finds

There are limits to what central banks can do. 

One reason for believing this is that monetary stimulus, operating through traditional (“flow”) channels, might now be less effective in stimulating aggregate demand than previously. 

Further, cumulative (“stock”) effects provide negative feedback mechanisms that over time also weaken both supply and demand. 

It is also the case that ultra easy monetary policies can eventually threaten the health of financial institutions and the functioning of financial markets, threaten the “independence” of central banks, and can encourage imprudent behavior on the part of governments. 

None of these unintended consequences is desirable. 

Mr. White's article is the economist's version of why central banks must observe Walter Bagehot's rule that interest rates must not be lowered below 2%.

For those who do not know:  Mr. White is one of the handful of economists that the economic profession hauls out to say there were some economists who predicted the financial crisis (without Mr. White and his colleagues at the Bank for International Settlements, the number of economists that predicted the financial crisis would have been countable on one or two fingers);  and Mr. Bagehot was the individual who in the 1870s wrote the book, Lombard Street, on modern central banking.

Mr. White makes one observation in particular that I would like to draw regular readers' attention to.

The unexpected beginning of the financial and economic crisis, and its unexpected resistance to policy measures taken to date, leads to a simple conclusion. The variety of economic models used by modern academics and by policymakers give few insights as to how the economy really works.

Please re-read the highlighted text again and then a third time as it is a highly respected economist answering the Queen's Question by saying although economists claim to have some insight into how the economy really works, in reality they have no clue.


The clear conclusion from Mr. White's observation that the economic models currently in use give few insights as to how the economy really works is that there is no reason to believe that any solution based on these models is likely to fix the problem with the financial system.