What Monetary Policy 3 (MP3) Will Look Like

Monetary Policy 1 was via interest rates. Monetary Policy 2 was via quantitative easing. It will be important for policy makers and us as investors to envision what Monetary Policy 3 will look like.

While monetary policy in the US/dollar has not fully run its course and lowering interest rates and quantitative easing can still rally markets and boost the economy a bit, the Fed’s ability to stimulate via these tools is weaker than it has ever been. The BoJ’s and ECB’s abilities are even weaker. As a result, central banks will increasingly be “pushing on a string.” Let’s take just a moment to review the mechanics of why and then go on to see what MP3 will look like.

Why “Pushing on a String?”

Lending in order to finance spending requires both investors/savers and borrowers/spenders, who have very different objectives, to each operate in both their own interests and in a symbiotic way. For example, when a debt expansion that finances spending on goods and services takes place, both a) the investors/savers increase their debt holdings because they believe that they are increasing their assets, and b) the borrowers produce those borrowings (that investors/savers call an ‘asset’) to increase their spending. When both are going on in a big way (i.e., when debts, financial assets, and spending are rising fast), we have a boom.

However, because both savers and borrowers often don’t do the calculations very well to determine whether the debt created will be used to produce more than enough income to service the debts, we also have busts. So, to understand how central banks’ monetary policies work, one has to see things through the eyes of both investors/savers and borrowers/spenders.

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