Central banks race to zero (2)

The Bank of England threw in the towel today, so to speak, by lowering its target interest rate to 0.5% and, by promising to buy tons of bonds, to effectively join the Fed in implementing "quantitative easing." The European Central Bank came close to joining the party by cutting its rate to 1.5%. Three out of the world's major central banks are now effectively targeting a zero interest rate, and the European and Canadian (0.75%) central banks are not far behind.

This says a lot about how powerful is the world's urge to hold money instead of other assets right now. Even when they offer to lend money at close to a zero interest rates, central banks can't find enough takers. Rather than borrow money, financial markets in aggregate are trying to do the opposite by deleveraging (i.e., by selling other assets to raise cash). By implementing quantitative easing, central banks are in a sense offering to help people deleverage directly, by buying the securities that financial markets are trying to sell. We could say that this makes them the "buyer of last resort."

This is not really about central banks pumping in money in an effort to get their economies moving again, it is about trying to accommodate a collective rush to the exits. Monetary policy has never been a good tool for stimulating growth, since its main purpose is to regulate inflation. So we shouldn't be too concerned that all this "easy money" hasn't yet resulted in a stronger growth or significantly higher inflation. By being the buyers of last resort, central banks are playing an effective role in alleviating this crisis of confidence, and that is helping markets to heal.

At some point the world's demand for money will satiated. Central banks will then have to reverse course, while running the risk of reacting too late and thus oversupplying the world with money for awhile.