For the past year, central banks have resorted to ever more ingenious methods to convince a sceptical public that they still have the ability to create inflation. This week, the Bank of Japan yet again broke ground in monetary policy, pledging to overshoot its 2 per cent inflation target and adopting a new tool to do so, in the form of a promise to cap 10-year bond yields at zero.
Yet its credibility is in question. A promise to let inflation rise above 2 per cent makes little difference when the BoJ has consistently failed to hit its existing target. And there is a widespread perception that the BoJ has decided to target yields chiefly because it will soon struggle to find enough bonds to buy under its previous strategy of asset purchase targets.
The European Central Bank faces its own version of this dilemma. Most economists think it will need to extend its quantitative easing programme past the deadline of March 2017, but it too could run out of bonds to buy unless it can overcome political and legal obstacles to broadening the pool of assets that are eligible.
Meanwhile, the US Federal Reserve is in the happier position of judging when to tighten policy, with reasonable economic growth, continued strengthening of the labour market and little sign that an interest-rate rise would trigger a repeat of the 2013 “taper tantrum” in emerging markets. Yet with inflation still quiescent, there is a real risk that a premature move would stop the recovery in its tracks - and with interest rates still close to historic lows, policymakers would then have little scope to counter the downturn.
The Fed was therefore right to leave policy on hold this week, especially given growing anxieties over November’s presidential election. However, the longer policymakers feel unable to raise rates, the more pressing becomes the question of how they will be able to counter the next recession. The assurances offered this month by Janet Yellen, the Fed’s chair, that a combination of forward guidance and quantitative easing would be sufficient to achieve this are not convincing.
None of this is to play down the vital role of central banks since the global financial crisis. Nor is it correct to say that the major central banks have run out of ammunition. However, it is true that they are having to adopt ever more extreme policies to achieve smaller effects. Very loose financial conditions do not seem to have the effect they once did on business investment or household borrowing.
The problem is that if central banks are to find new sources of stimulus, they will increasingly have to venture into political territory. In the eurozone and Japan, whether or not further innovations in quantitative easing prove possible, long-term interest rates are incredibly low.
The easiest way to regain traction would be to cut short-term interest rates far more aggressively into negative territory. But this would be deeply unpopular, since it would need restrictions on the use of cash to be effective. This may become feasible over time but economist Kenneth Rogoff, one of its noted proponents, is still receiving death threats for raising the idea.
Moreover, the conviction is mounting that the problem may be more structural than cyclical - with expansion in many developed economies held back by low productivity growth, and ageing populations with a propensity for saving over spending. Reluctance to invest may also reflect fears over geopolitical risks and creeping populism. Central banks cannot cure all these ills.
Yet the longer they fail to meet their core goals, the more corrosive the effect on their credibility.
