September 16 2008 was the day central banks stopped being boring. The day Lehman Brothers went down was the cut-off point between conventional monetary policy – moving official interest rates in baby steps to keep inflation low – and unconventional monetary policy.
Interest rates came down in big leaps to barely above zero. Central banks bought long-term government bonds and risky assets, providing money in return in the process known as quantitative easing. Forward guidance embedded the idea that borrowing would remain cheap for a long time. Schemes, such as the Bank of England's Funding for Lending, were introduced to get the commercial banks lending once more. The rule book was torn up.
Almost six years on, the post-Lehman regime remains in place. The perceived wisdom among central banks is that unconventional monetary policy prevented a deep recession turning into a second Great Depression and that unwinding the emergency measures too quickly would threaten what is still a tentative global recovery.
A new working paper by two International Monetary Fund economists does not challenge the idea that things could have turned really nasty had it not been for the slashing of interest rates, QE and all the other wheezes dreamed up by central banks. Even so, the paper by Frederic Lambert and Kenichi Ueda (The effects of unconventional monetary policies on bank soundness) makes uncomfortable reading.
It argues that the policies pursued by central banks since 2008 have not made commercial banks more profitable. But they have made banks riskier and more likely to delay repairs to their balance sheets. "Unconventional monetary policy is often assumed to benefit banks. However, we find little supporting evidence. Rather, we find some evidence for heightened medium-term risks", Lambert and Ueda say.
The implications are clear. One of the side effects of unconventional monetary policy is that banks are encouraged by low interest rates to seek out higher yielding – and riskier – investments, while QE gives them more scope to do so. The risks increase the longer the unconventional policies remain in place.
Lambert and Ueda do not speak for the IMF, which has been a keen supporter of unconventional policies. Even so, this is an important paper. It suggests that the Fund and the world's leading central banks need an exit strategy from the policies of the past six years. Otherwise, they could be storing up big problems for the future.
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