Central Banks in Balance Sheet Recessions:A Search for Correct Response
Richard C. KooChief EconomistNomura Research InstituteMarch 31, 2013These are extraordinary times for central banks. Near zerointerest rates and massive liquidity injections are still failing tobring life back to so many economies in the developed world. If we set the pre-Lehman Shock level as 100, the Federal Reservehas increased monetary base to 347 today, while the Bank of England increased its monetary base to 433 during the sameperiod, all under the lowest interest rates in their modernhistories. Yet, the US is still suffering from an unemploymentrate of 7.7 percent after four years of zero interest rates, and theUK is in the midst of a double-dip recession. The Bank of Japanhas increased its monetary base from 100 in 1990 to 363 today,but instead of facing a triple digit inflation rate, it is facing adeflation. The European Central Bank has brought interestrates down to the lowest level in modern European history, butthe unemployment rate at 11.9 percent is at the highest since theintroduction of Euro. The increases in monetary base are shownin Exhibit 1.
Private sector is minimizing debt instead of maximizingprofits
These unusual phenomena are all caused by the fact that privatesectors in all of these countries are massively increasing savingsor paying down debt despite record low interest rates. Accordingto the flow of funds data, the US private sector (household,corporate and financial sectors combined) today is savingwhopping 6.9 percent of GDP (four-quarter moving average