Too Much Global Liquidity from Central Banks Distorts Financial Markets and Undermines Economic Growth

Abstract

In the wake of the 2008 financial crisis and the ensuing global recession central banks flooded the financial system with liquidity to overcome fears of contagion that froze the credit markets and threatened the solvency of major banks. Accordingly, the Federal Reserve Bank along with central banks in Europe, China, Japan and elsewhere engaged in quantitative easing involving the purchase of respective sovereign debt securities creating money in the process. As a consequence, interest rates have been at historic lows to accommodate economic recovery.

While initially beneficial for calming the financial markets and jump-starting the economy, five years hence aggressive monetary policy still has failed to achieve the economic growth required to create jobs and restore prosperity. Rather, abundant global liquidity and attendant low interest rates have inflated stock prices, encouraged risky investing in the chase for higher returns, devalued currencies in a race to the bottom to compete in export markets, and inflated commodity prices until slow growth in China curtailed demand. In addition, the low interest rates suppress discipline in government borrowing while sovereign debt hovers at crisis levels. Meanwhile, savers are punished to the detriment of the economy as the national income that would have been generated by normal interest rates is forfeited. Furthermore, many speculate about potential inflation arising from all the liquidity when robust growth resumes.

Rather than create potential asset bubbles in the financial markets, significant fiscal reform is needed to revive the real economy from its protracted slow growth pattern. Tax cuts, spending reduction and regulatory relief encourage investment in plant, equipment and inventory that creates jobs that stimulate the consumer sector. Indeed, such policy would break the logjam created by uncertainty about taxes, regulation and the activities of the Fed. Tax increases on the wealthy are counterproductive. Sequestration is hardly enough. Stifling energy production is irresponsible. And continued monetary interference is ineffective.

Keywords: economic growth, low interest rates, central bank accommodation, financial asset bubbles, fiscal reform