Edging ever closer to the Japanese doldrums

SERIOUS MONEY:IT IS ALMOST four years since central banks in the western world first adopted near-zero interest-rate policies alongside the implementation of substantial quantitative easing measures in an effort to halt the sharp and swift decline in economic activity that followed the acute myocardial infarction that struck at the heart of the global financial system.

The prescribed medicine successfully revived ailing advanced economies, but failed to restore the patient to full health. The deterioration in vital signs in the years leading up to the crisis, precluded a rapid and robust recovery, no matter how high the dosage.

The lacklustre recovery – characterised by persistently elevated levels of unemployment, and subpar business investment rates – has seen central bankers reaffirm their commitment to do “whatever it takes”, in the words of European Central Bank president Mario Draghi, to return the industrialised world to a more familiar growth-setting.

The rhetoric has been followed by action, as monetary policymakers in Frankfurt and Washington reached into their medicine chests, and upped the dosage in an effort to remove negative fat-tail risks, and keep their economies afloat.

Return-starved investors’ anticipation of further monetary stimulus fuelled an unseasonal rally in the world’s major stock market averages during the summer – with prices advancing close to multi-year highs. Surprisingly, the robust double-digit, percentage point gain in equity values has taken place in spite of mounting evidence that global growth has slowed to stall-speed, which is often a prelude to recession.

Stock market indices have moved higher on economic data, both “good” and “bad”, which means investors must believe central bank action will ultimately result in a significant improvement in economic activity. This conviction is difficult to fathom, given that the ambitious monetary policies pursued in both Europe and the US post-crisis, have already failed in igniting anything like a standard recovery, and that further life-support operations are required simply to sustain economic growth not too far below trend.

The evidence of the past four years is virtually a carbon copy of the Japanese experience following the collapse of its twin property and stock market bubbles in the early-1990s. The Bank of Japan reduced short-term policy rates somewhat belatedly to zero in 1996, and launched the first in a series of quantitative easing programmes early in the new millennium.

However, the unconventional policies adopted in Japan did not produce any real traction in the economy, and the nation’s economic output is now 40 to 50 per cent below the level that reasonable forecasters would have projected it to be way back in 1991. Ultra-accommodative monetary policy was unable to prevent two decades of economic stagnation, as the banking crisis and private sector deleveraging that followed the implosion of the credit-fuelled asset bubbles, seriously curtailed its potency.