The beginning of the global economic and financial crisis is now almost exactly ten years behind us, but in international monetary policy the crisis is as present as if it had happened yesterday. Almost all the major central banks, at least in the industrialised nations, are keeping key lending rates at zero or only a little above that, and in many countries liquidity is still constantly being pumped into the markets by asset purchases. Such a long phase of extremely expansionary monetary policy is unprecedented.
At present, however, and not only in the USA and Euroland, there are increasing signs that a major upheaval in monetary policy is in the offing. Admittedly it currently looks as though it may take place very slowly, as the central banks have no reason to rush things. Indeed, while the prospects of inflation have risen, they are still limited in scale.
This need not remain the case. Especially in the USA there is the risk that the inflation rate will pick up, which would put the Fed under pressure. What monetary policy course would it then follow?
With regard to the monetary policy of the past few decades, you can distinguish between three consecutive phases or regimes: The end of the 1960s saw the beginning of the first phase, with inflation being combatted by monetary policy means, and this persisted until the late 1980s or early 1990s. From the early 1990s onwards monetary policy was more “growth-driven” and the battle against inflation took a back seat. When the economic and financial crisis broke out in 2007, monetary policy realigned to concentrate on combatting the crisis, a thrust that continues to this day. New instruments were developed to this end and the central banks’ focus shifted increasingly from the real economy to the financial markets.
What is the new strategy? Initially, a return to the strategy of managing growth would seem obvious: It was the prevailing paradigm prior to the financial market crisis and most players in those markets can more or less still remember it well. That strategy could in the coming one to two years already lead to interest rates being raised on a scale that clearly exceeds the current market consensus.
The central banks could see themselves also forced to return to the anti-inflationary policies of the 1970s and 1980s. The world-wide attempts to oppose free trade could lead to such a recurrence of inflation. More protectionism leads directly to higher prices as it limits competition in the goods and labour markets. Tendencies to turn back the reforms in the labour markets run in the same direction. This could spell a rude awakening for the financial markets, which have in recent years been spoiled by an overly caring monetary policy.