The combination of low short-term rates and asset purchase programs has driven yields on long-term sovereign debt to historically low levels (Figure 2). In large parts of Europe and Japan, short- and long-term yields remain near zero, a full decade after the onset of the financial crisis. Economic developments since this unprecedented monetary stimulus provide valuable insights into the efficacy and limitations of monetary policy. On the positive side of the ledger, advanced economies have seen steady growth and significant declines in unemployment, with rates today near, or in many cases well below, those seen before the crisis (Figure 3). Bold monetary policy actions surely played an important role in averting far greater catastrophes and aided economic recovery. However, this success was achieved only after a disappointingly slow recovery and many years of economic hardship. And, despite the improvement in the real side of economies, inflation rates have persistently been below central banks’ goals (Figure 4). The fact that inflation has been running below target in most advanced countries—the United Kingdom being the most prominent outlier—suggests that this challenge is not due to factors specific to a single country. Instead, there are more systemic factors at play. Investors view these low inflation readings not as an aberration, but rather a new normal. This is evidenced by a broad-based decline in market-based measures of longer-run inflation expectations since the mid-2000s, with the UK again providing the exception (Figure 5).
The Bank of Canada already regularly does this, and the Federal Reserve is currently undergoing a review of its framework and strategy.8 Absent such changes, central banks will be severely challenged to achieve stable economies and well-anchored inflation expectations. Outside of monetary policy, there are a number of avenues by which fiscal authorities can enhance the resilience of economies to negative shocks. One is to strengthen the “automatic stabilizers” that provide a boost to the economy during a downturn. A second is to align debt management decisions more with monetary policy. For example, during a downturn, the fiscal authority could choose to shorten the duration of debt issuance to reinforce the effects of central bank quantitative easing. Third, regulatory and supervisory policies that support the resilience of the financial system can limit the economic effects of negative shocks. Finally, fiscal and other economic policies can attack directly the sources of slow growth and low r-star. This includes raising public and private investment in human and physical capital, infrastructure, science and technology, and policies aimed at removing barriers to participation in the labor force and the economy more broadly. Conclusion The facts have changed, and so it is time our change our minds also. It is often said that change is hard. But, experience teaches us that it is better to prepare for the future than wait too long. Ultimately, failure to prepare often means preparation for failure. 1 This is not true for all population groups.