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Symposium 2015

Virtual Library File - Ultra Easy Monetary Policy and the Law of Unintended Consequences

The Challenge

With the onset of the Financial Crisis 2008 many central banks worldwide considerably eased their monetary policies. Some central banks, like the Federal Reserve, the European Central Bank, and the Ba ...

With the onset of the Financial Crisis 2008 many central banks worldwide considerably eased their monetary policies. Some central banks, like the Federal Reserve, the European Central Bank, and the Bank of England, quickly reached the zero-lower-bound on nominal interest rates; these central banks then started conducting extraordinary measures like quantitative easing and forward guidance. There is some consensus that this massive monetary stimulus in the first, ‘acute’, phase of the crisis was largely appropriate, preventing a second Great Depression. However, since then, discussion has turned toward how long monetary policy should remain highly expansionary, because of doubts about the effectiveness of expansionary monetary policy in the aftermath of banking crises. Moreover, expansionary monetary policy over a long period of time might be associated with adverse side effects such as financial instability, asset price bubbles, slower structural adjustment, distorted investment decisions, and inflation.

This paper comprehensively discusses the effectiveness and unintended consequences of ultra-ease monetary policy. It argues that monetary policy currently could be less effective because important transmission channels may be at least partially blocked. Moreover, it argues that ultra-ease monetary policy can eventually threaten the health of financial markets and the “independence” of central banks and can encourage imprudent behavior of governments. It may also trigger capital misallocation.