Five years into the great financial crisis, central banks are still pushing back the boundaries of monetary policy only to encounter constant reminders of the limits of their power to revive growth.
The Bank of England's provision of cheap loans to fund new bank lending and Denmark's adoption of a negative deposit rate are the most recent evidence that central banks are far from running out of firepower.
Conventional monetary policy may be constrained because interest rates in major economies are close to zero, but central bankers retain a plethora of less orthodox options and are increasingly likely to resort to them in coming months if growth prospects keep deteriorating.
Possible courses of action include buying private-sector assets, not just government bonds, and charging banks for parking funds at the central bank with the aim of galvanizing them into lending the money instead.
Central banks are rummaging though their toolkits because, despite slashing interest rates and buying vast quantities of bonds, they have signally failed to revive a global economy hamstrung by heavy debts and weak banks.
Andrew Kenningham with Capital Economics, a London consultancy, said he was not surprised that large scale asset purchases had not worked as well as some had hoped.
"It's questionable how effective monetary policy can be, full stop. And it's questionable whether the monetary authorities will do enough unless the situation becomes even worse, at which point it might be a case of putting a floor under the downside risks rather than promoting a stronger recovery," he said.
KING KEEPS COOL
Bank of England Governor Mervyn King bristles at the suggestion that central bankers are still being too timid.
"This has been an extraordinary period of monetary easing on a scale never before seen, and central banks still have got their foot to the floor," King told a news conference on Wednesday to present the bank's latest inflation report.
But, with the BOE forecasting that output in Britain will not regain pre-crisis levels until 2014, King had to fend off suggestions that the bank's purchase of 375 billion pounds ($586 billion) worth of government bonds had been a failure.
Wasn't it time, he was asked, to try something more radical than 'quantitative easing'? How about directly financing government deficits? How about cancelling the bonds the BOE has bought to create room for tax cuts? How about bypassing the banks and handing out newly printed central bank money to the public — the late U.S. monetarist economist Milton Friedman's famous 'helicopter drop'?
King rejected the invitation for unelected central bankers to venture into the government's fiscal policy territory. "You'd be the first person to criticize us for appalling behavior," he told his questioner.
Kenningham said he was disappointed that less controversial alternatives were not on the table. "There doesn't seem to any serious discussion of even more moderate things, such as raising the inflation target to, say, 4 percent for a few years," he said.
Nevertheless, leading central banks are unlikely to sit on their hands.
WHAT TO DO
At the European Central Bank, President Mario Draghi, promising "to do what it takes," has flagged plans to resume bond buying on the grounds that high sovereign bond yields in vulnerable euro zone countries are impairing the transmission of monetary policy.
In addition, Goldman Sachs expects the ECB to permit the euro zone's 17 national central banks to buy unsecured corporate and bank debt to ease financial conditions.
Speculation also persists that the ECB could follow Denmark and further cut its deposit rate, already at zero, even though Draghi has said this would be entering uncharted territory.
"We think that the concerns about negative side effects on banks and money market funds of negative interest rates will not be a barrier to further rate reductions in response to the deteriorating economic outlook," Nick Kounis and Ruben van Leeuwen, economists at ABN AMRO, said in a report.
In the United States, Federal Reserve Chairman Ben Bernanke has expressed keen interest in the BOE's new "Funding for Lending" scheme, which offers banks cheap central bank money on condition they lend it into the economy.
Economists also expect a third round of quantitative easing from the Fed if the economy relapses.
The Fed bought $600 billion in securities in its second round of asset purchases, but BNP Paribas sees a one in four chance that next time round the Fed will not set a ceiling on the program. Instead, the bank could decide to expand its balance sheet until the economy is back on its feet.
"If the Fed were to take the leap into the relative unknown of open-ended QE, we think that its cumulative size would have to be substantially larger than the $600 billion for the Fed to achieve its desired goals," economists Julia Coronado and Jeremy Lawson said in a report.
It was BNP Paribas that flagged the financial crisis five years ago today when it announced big losses in sub-prime mortgage investments.
Among other central banks, economists expect the BOE to embark on its own third round of QE in November, while the Swiss National Bank is seeking to avert the danger of deflation by capping the value of the Swiss franc against the euro.
In Japan, which was the first to try QE in the early 2000s with limited success, a debate is swirling about the political and legal propriety of having the Bank of Japan buy foreign bonds — a variation on the theme of currency market intervention to ease financial conditions and counter deflation.
There is no shortage of much more exotic policy stimulus options along the lines of Friedman's helicopter drop.
As the BOE's King says, he and other policymakers have studied the theory and practice of monetary economics to death.
"These things are well known. But that doesn't make it any easier to work out how to move out of this," he lamented.
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