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The world’s central banks are engaged in one of the great policy experiments in modern history: ultra-easy money. And, as the experiment has continued, the risk of failure – and thus of the wrenching corrections and deep economic dislocations that would follow – has grown.

In the wake of the crisis that began in 2007, policy rates were reduced to unprecedented levels, where they remain today, and measures were taken to slash longer-term rates as well. Nothing like it has ever been seen before at the global level, not even in the depths of the Great Depression. Moreover, many central banks’ balance sheets have expanded to record levels, although in different ways and for different rationales – further underscoring the experimental character of the monetary easing now underway.

The risks implied by such policies require careful examination, particularly because the current experiment appears to be one more step down a well-trodden path – a path that led to the crisis in the first place.

Beginning with the sharp monetary-policy easing that occurred following the 1987 stock-market crash, monetary policy has been used aggressively in the face of every economic downturn (or even anticipated downturn) ever since – in 1991, 1998, 2001, and, with a vengeance, following the events of 2007. Moreover, subsequent cyclical tightening was always less aggressive than the preceding easing. No surprise, then, that policy rates (both nominal and real) have ratcheted ever downward to where they are today.

It can, of course, be argued that these policies produced the “Great Moderation” – the reduction in cyclical volatility – that characterized the advanced market economies in the years leading up to 2007. Yet it can also be argued that each cycle of monetary easing culminated in a credit-driven “boom and bust” that then had to be met by another cycle of easing. With leverage and speculation increasing on a cumulative basis, this whole process was bound to end with monetary policy losing its effectiveness, and the economy suffering under the weight of imbalances (or “headwinds”) built up over the course of many years.

The Swedish economist Knut Wicksell raised concerns about such problems long ago. He suggested that a money rate of interest (set in the banking system) that was less than the natural rate of interest (set in the real economy) would result in inflation. Later, economists in the Austrian tradition noted that imbalances affecting the real side of the economy (“malinvestments”) were of equal concern.

Later still, Hyman Minsky contended that credit creation in a fiat-based monetary economy made economic crises inevitable. Finally, many economists in recent decades have identified how excessive leverage can do lasting damage to both the real and financial sides of the economy.

Looking at the pre-2007 world, there was ample evidence to warrant such theoretical concerns. While globalization was holding down inflation, the real side of the world economy was exhibiting many unusual trends. Household saving rates in the English-speaking economies fell to unprecedented levels. Within Europe, credit flows to peripheral countries led to unprecedented housing booms in several countries. In China, fixed capital investment rose to an astonishing 40% of GDP.

Moreover, similar unusual trends characterized the financial side of the economy. A new “shadow banking” system evolved, with highly pro-cyclical characteristics, and lending standards plummeted even as financial leverage and asset prices rose to extremely high levels.

The monetary policies pursued by central banks since 2007 have essentially been “more of the same.” They have been directed toward increasing aggregate demand without any serious concern for the unintended longer-term consequences.

But it is increasingly clear that ultra-easy monetary policy is impeding the necessary process of deleveraging, threatening the “independence” of central banks, raising asset prices (especially for bonds) to unsustainable levels, and encouraging governments to resist making needed policy changes. To their credit, leading central bankers have stated repeatedly that their policies are only “buying time” for governments to do the right thing. What is not clear is whether anyone is listening.

One important impediment to policy reform, on the part of both governments and central banks, is analytical. The mainstream models used by academics and policymakers differ in important respects but are depressingly similar in others. They emphasize short-term demand flows and presume a structurally stable world in which probabilities can be assigned to future outcomes – thus almost entirely ignoring uncertainty, stock accumulations, and the financial imbalances that characterize the real world.

Recalling John Maynard Keynes’s dictum that “the world is ruled by little else” but “the ideas of economists and political philosophers,” perhaps policymakers need new ideas. If so, the immediate prognosis for the global economy is not good. The latest fashion in policy advice is essentially still more of the same.

The call for “outright monetary financing” involves raising government deficits still further and financing them through a permanent increase in base money issued by central banks. Targeting the level of nominal GDP (or the unemployment rate, as in the United States) is a way of convincing financial markets and potential spenders that policy rates will remain very low for a very long time. All of these policies run the risk of higher inflation and/or still more dangerous economic imbalances.

Sadly, a fundamental mainstream reassessment of how the economy works is by no means imminent. It should be.

William White, a former deputy governor of the Bank of Canada and a former head of the Monetary and Economic Department of the Bank for International Settlements, is chairman of the Economic and Development Review Committee at the Organization for Economic Cooperation and Development (OECD).

© 2013 Project Syndicate.

I first entered the System as a neophyte economist in 1949. Then, as now, the Federal Reserve was committed to maintaining a pattern of very low interest rates, ranging from close to zero at the short end to 2½ percent or less for Treasury bonds. If you feel a bit impatient about the situation now, quite understandably so, recall that the earlier episode lasted 15 years.

The initial steps taken in the midst of the 1930’s continuing depression were at the Fed’s initiative. The pattern was held through World War II in explicit agreement with the Treasury. Then it persisted right in the face of double-digit inflation after the war, increasingly under the duress imposed by the Treasury and Presidential pressure.

The growing restiveness of the Federal Reserve was reflected in testimony by Mariner Eccles in 1948: “Under the circumstances that now exist, the Federal Reserve System is the greatest potential agent of inflation that man could contrive.”

That was pretty strong language by a sitting Fed governor and a long-serving Board Chairman. But it was then a fact that there were many doubts about whether the formal legal status of the central bank could or should be sustained against Treasury and Presidential importuning. At the time, the influential Hoover Commission on government reorganization itself expressed strong doubts. At any rate, over time calls for freeing the market met strong resistance.

Treasury debt had ballooned in the War, exceeding 100% of GDP, so there was concern about an intolerable impact on the budget if interest rates rose strongly. Ending Federal Reserve support might lead to panicky and speculative reactions, and declines in bond prices would drain bank capital. Main line economists, and the Fed itself, worried that a sudden rise in interest rates could put the economy back in recession.

All of that resonates today, some 60 years later, even if few now take the extreme view of the first report of the then new Council of Economic Advisors: “Low interest rates at all times and under all conditions, even during inflation” would be desirable to promote investment and economic progress. Not exactly a robust defense of the Federal Reserve and independent monetary policy.

Eventually, the Federal Reserve did get restless, and finally in 1951 rejected overt Presidential pressure to continue the ceiling on long-term Treasury rates. In the event, the ending of the “peg” was not dramatic. Interest rates did rise over time, but long bonds, with markets habituated for years to a low interest rate, remained at moderate levels. Monetary policy, free to act against incipient inflationary tendencies, contributed to 15 years of stability in prices, accompanied by strong economic growth and high employment. The recessions were short and mild.

No doubt, the challenge of orderly withdrawal from today’s broader regime of “quantitative easing” is far more complicated. The still-growing size and composition of the Fed’s balance sheet implies the need for, at the least, an extended period of “disengagement.” Moreover, the extraordinary commitment of Federal Reserve resources, alongside other instruments of government intervention, is now dominating the largest sector of our capital markets, that for residential mortgages. Indeed, it is not an exaggeration to note that the Federal Reserve, with assets of $3.5 trillion and growing, is, in effect, acting as the world’s largest financial intermediator, acquiring long-term obligations and financing short-term, aided and abetted by its unique privilege to create its own liabilities.

Beneficial effects of the actual and potential monetization of public and private debt, the essence of the QE program, appear limited and diminishing over time. The old “pushing on a string” analogy is relevant. The risks of encouraging speculative distortions and the inflationary potential of the current approach plainly deserve attention. All of this has given rise to debate within the Federal Reserve itself. In that debate, I trust sight is not lost of the merits—economically and politically—of an ultimate return to a more orthodox central banking approach.

I do not doubt the ability and understanding of Chairman Bernanke and his colleagues. They have a considerable range of tools and instruments available to them to manage the transition, including the novel approach of paying interest on excess reserves, potentially sterilizing their monetary impact. What is at issue—what is always at issue—is a matter of good judgment, leadership, and institutional backbone. A willingness to act with conviction in the face of predictable political opposition and substantive debate is, as always, a requisite part of a central bank’s DNA.

Those are not qualities that can be learned from text books. Abstract economic modeling and the endless regressions of econometricians will be of little help. The new approach of “behavioral” economics itself is recognition of the limitations of mathematical approaches, but that new “science” is in its infancy.

A reading of history may be more relevant. Here and elsewhere, the temptation has been strong to wait and see before acting to remove stimulus and then moving toward restraint. Too often, the result is to be too late—to fail to appreciate growing imbalances and inflationary pressures before they are well ingrained.

There is something else beyond the necessary mechanics and timely action that is at stake. The credibility of the Federal Reserve, its commitment to maintain price stability, and its ability to stand up against pressing partisan political pressures is critical. Independence can’t just be a slogan. Nor does the language of the Federal Reserve Act itself assure protection, as was demonstrated in the period after World War II. Then, the law and its protections seemed clear, but it was the Treasury that for a long time called the tune.

In the last analysis, independence rests on perceptions of high competence, of unquestioned integrity, of broad experience, of non-conflicted judgment and the will to act. Clear lines of accountability to the Congress and the public will need to be honored.

Moreover, maintenance of independence in a democratic society ultimately depends on something beyond those institutional qualities. The Federal Reserve—any central bank—should not be asked to do too much, to undertake responsibilities that it cannot possibly meet with the appropriately limited powers provided.

© 2013 RIJ Publishing LLC. All rights reserved.

The performance of the variable annuity business in the first quarter of 2013 was mixed.

This year isn’t starting out as strong as 2012 did. Net cash flow into VA contracts—sales minus surrenders, exchanges and distributions—was 76.3% lower in the first quarter of 2013 than in the same quarter a year earlier, according to Morningstar’s Annuity Research Center. At $34.3 billion, total first quarter sales figures were down from $35.7 billion in 1Q 2012.

But 2013 started better than 2012 ended. Net cash flow in 1Q 2013 rose versus 4Q 2012 ($900 million vs. minus $600 million) and sales were up slightly, from $33.9 billion in the final quarter of 2012. Helped by a bull market that pushed the DJIA over 15,000 for the first time, VA assets under management at the end of the first quarter 2013 reached a new record of $1.72 trillion, up from $1.64 trillion at the end of 2012.

The overall figures are hard to interpret, however, because the industry is still shaking out and products continue to evolve. The sales leaders are still thriving—especially Jackson National—but the products are generally stingier. “The remaining active retail market companies are largely above water on a net basis, while cash drains from group contracts and exited companies con tinue to be the main culprits driving the low industry number,” wrote Frank O’Connor, director of the Annuity Research Center, in his quarterly report.

De-risking of products can only hurt sales. When VA income riders were patently underpriced in 2005 through 2007, advisors recognized the opportunities and took advantage of them.  As products have become more accurately, and even defensively, priced, demand will inevitably suffer, even at a time when 10,000 Boomers are reaching age 65 daily. 

The fastest growing product in the first quarter was Jackson National’s Elite Access B share. A year ago, shortly after it was launched, it was ranked 217^th in sales. At the end  of 1Q 2013, it was ranked 10^th, with $785.5 million in sales.

Other contracts that have moved up significantly in the rankings over the past year are AXA’s Structured Capital Strategies B-Series, and two from Pacific Life: the Destination O-Series and Innovations Select. Neither Elite Access nor Structured Capital Strategies  is aimed at providing lifetime income, but rather to offer tax-advantaged exposure to alternative investments and a buffer against losses, respectively. 

In the various distribution channels, competition is most intense in the asset-rich wirehouse channel. Prudential, Jackson National and Lincoln Financial were the first quarter 2013 leaders in the wirehouses, with sales of $575.8 million, $562.8 million and $526.1 million, respectively. Meanwhile, Lincoln Financial and MetLife fought for leadership in the regional broker/dealer channel, with sales of $670.2 million and $639.7 million, respectively.  

The VA industry remains highly consolidated. The ten largest issuers accounted for about 79% of all sales in the first quarter, and the five largest issues accounted for more than half of all sales.

© 2013 RIJ Publishing LLC. All rights reserved.