Can Central Banks Goose Growth?

Bold Action Is Needed to Fight the Next Downturn

Activists with the Center for Popular Democracy protest a likely increase in the interest rate by the Federal Reserve in front of the Federal Reserve bank in New York, December 2015. Stephanie Keith / Reuters

In the years since the global financial crisis of 2008 engulfed the world and the United States fell into the Great Recession, the panic has subsided and Western economies have recovered to varying degrees. But the downturn’s effects have proved profound and lasting, and serious risks persist for the global economy. The recovery has been slow, inflation levels remain below the targets set by central banks, and total debt levels are much higher than before the crisis began.

Worst of all, at least two dozen countries—some with developed economies, others with emerging markets—find themselves either at or very close to the so-called zero lower bound, meaning that their short-term nominal interest rates hover around zero. At the zero lower bound, central banks struggle to stimulate growth, since the simplest way for them to do so—dropping interest rates even further—becomes nearly impossible when rates are already (almost) as low as they can go. The U.S. Federal Reserve has recently begun to raise interest rates because the American economy has sufficiently improved, a step that has moved the United States slightly away from the zero lower bound. But Japan, the countries of the eurozone, and many others are still stuck with weak economies and interest rates at or close to zero.

Central banks have already applied almost every traditional policy tool, as well as some unconventional and even radical ones, and yet economic outlooks everywhere remain uncertain. In a sense, then, the global economy is traveling without shock absorbers. Another downturn—even a relatively ordinary one—would require central bankers to once again turn to experimental and seemingly risky monetary policies, as they did in response to the financial crisis. Traditional tax cuts and spending packages would help but would likely prove insufficient: debt is already very high, and intense political opposition to increasing it exists in many countries.

Many investors, and even some economists and analysts, have grown complacent in recent years as the global economy has

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