By Sylvester Eijffinger and Edin Mujagic
(Project Syndicate) – Federal Reserve Chairman Ben Bernanke’s recent announcement that the Fed would maintain the current pace of monetary stimulus in the United States has cinched it: economics textbooks, at least the chapters on monetary policy, need to be rewritten.
After US investment bank Lehman Brothers collapsed in 2008, it did not take long for advanced-country central banks to recognize that conventional monetary policy would be inadequate to contain the fallout of the ensuing crisis. So they bucked accepted theory, as set forth in standard textbooks like Principles of Economics by Greg Mankiw and Money, the Financial System, and the Economy by Glenn Hubbard, in favor of so-called “unconventional” monetary policy.
Five years later, these policies remain intact. This means that today’s undergraduates – and recent graduates – have studied economics during a period of uninterrupted reliance on near-zero interest-rate policies (ZIRP) and large-scale asset purchases, known as quantitative easing (QE). For them, a federal funds rate (the interest rate that banks charge each other for overnight loans of their reserves held at the Fed) of 5% seems as fantastic as a unicorn.
More important, this inversion is likely to persist. Central banks are using so-called “forward guidance” to assure market participants that they will, to some extent, maintain ZIRP and QE for years to come. In short, what was once standard has become almost unthinkable, and the exceptional has become the norm.