An ‘F’ Grade for the World’s Major Central Banks

In an article from early last year, I quoted the late MIT economist Rudi Dornbusch, who remarked of the Bank of Mexico’s board members that he could understand their mistakes. After all, they were human. 

However, what he could not understand was how they could make the same mistake repeatedly. Whoever first said — it almost certainly was not Einstein — that insanity is doing the same thing over and over again and expecting different results might have come up with an unflattering explanation. 

We have to wonder what he or she might have said about the world’s major central banks, which keep mistakenly reacting to each economic downturn with excessively loose monetary policies that are maintained for too long. By doing so, the banks fuel inflation, encourage reckless lending, cause financial market mis-pricing, and facilitate the excessive debt build up. They then seem to be surprised by the financial crisis that inevitably follows their monetary-policy irresponsibility. 

Take, for example, the Federal Reserve. What was it thinking in 2021 when it maintained its zero-interest policy and allowed the broad money supply (M2) to balloon by 40 percent? It did so at a time when the economy was recovering satisfactorily and was receiving the largest emergency-aid package in U.S. history. And what was it thinking when it kept buying $120 billion a month in U.S. Treasury bonds and mortgage-backed securities, thereby allowing its balance-sheet size to increase to a staggering $9 trillion? It did so even at a time when the stock market and credit markets were on fire.

One result of the Fed’s monetary policy largesse was surging inflation that reached a multi-decade high of over 9 percent in June, 2022. Another was that it subsequently forced the Fed to raise interest rates at the fastest rate in decades to regain inflation control.

The economy has proved more resilient (so far) than I expected, but that does not change the fact that the Fed’s monetary-policy hawkishness has caused massive mark-to-market losses exceeding $1 trillion in the banking system’s bond and loan portfolios. It is also aggravating the ongoing commercial-property disaster caused in part by different work and shopping habits in a post-pandemic world. This must make it only a matter of time before we have another round of the U.S. regional-bank crises. Indeed, a recent National Bureau of Economic Research report is anticipating the failure of over 300 small and medium-sized U.S. banks.

For its part, the Bank of China’s monetary-policy response to the 2008-2009 recession led to the mother of all housing-market and credit-market bubbles. The International Monetary Fund estimates that, over the past decade, China experienced a larger credit-market bubble than that preceding Japan’s lost economic decade in the 1990s and that preceding the 2008 U.S. crisis. The bursting of the Chinese housing- and credit-market bubble now is likely setting China up for its own lost economic decade.

Meanwhile, the European Central Bank’s negative-interest-rate policy and massive bond-purchasing programs has enabled a number of important Eurozone member countries to run irresponsible budget policies. That has contributed to a situation where the debt levels of key Eurozone member countries, like France and Italy, are now higher than they were at the time of the 2010 Eurozone debt crisis. That all too likely is setting us up for another round of the Eurozone debt crises in countries that are many times the size of the Greek economy. This would seem to be especially the case given the increased political instability and polarization in France. 

In the same way as a student who does not learn from his mistakes is given an F grade, so too should the world’s major central banks for once again having flooded the market with excessive lending and for keeping interest rates too low for too long. By so doing, they helped let the inflation genie out of the bottle and they have set us up for yet another financial crisis.