Are central banks running out of steam?

I have been inundated lately with requests from readers to explain the recentevolution of monetary policy practices happening here and around the world.

Iadmit, it's all very confusing, and all I can do is quote from Alice in Wonderland,"Curiouser and curiouser." Like Alice who 'forgot how to speak good English',central bankers have forgotten how to do good policy.

So what went wrong? If blame has to be laid at someone's feet, I would lay it at thefeet of bad economic models, on two fronts.

First, the macroeconomic models usedby most mainstream economists are not representative of modern economies.

In aspeech at Princeton University on September 24, 2010, former Fed Chairman BenBernanke admitted as much: "the standard models [used by economists] weredesigned for these non-crisis periods."

In other words, most models used bymainstream economists have nothing to say about the current situation, andtherefore nothing to propose in terms of policy.

Second, over the last three decades, these models downplayed the role of fiscalpolicy, as a consensus emerged that economic growth comes first and foremost frommonetary policy.

Fiscal deficits were thought to lead to inflation and higher interestrates.Yet the huge fiscal spending in 2009 led to neither higher inflation nor higherinterest rates, which have remained at historical lows.

These models encouraged politicians, economists and central bankers to leave allthe economic responsibility with monetary policy.

The only problem with this approach is that it did not work.In fact, it made thingsworse. What's more, economists don't seem to have learned much from the'disastrous decade', as many are calling for even more monetary stimulus.

Consider the evolution of monetary policy since the crisis. Since the crisis, monetarypolicy has relied on two planks: quantitative easing (QE) and, more recently,negative interest rates both policies sharing similar characteristics.

Quantitative easing, which was championed as a sure policy to rescue our failingeconomies, was based on the idea that banks did not have sufficient liquidity tomake new loans.

If banks could lend more, the economy would pick up (hence, noneed for fiscal policy).

In 2009, then Governor Ben Bernanke stated "The idea behind quantitative easing isto provide banks with substantial excess liquidity in the hope that they will chooseto use some part of that liquidity to make loans or buy other assets."

Well it did not work.The only affect of QE was to inflate the asset market (that'sanother story).

So central banks moved on to the next great idea: negative interest rates, which arein fact an implicit admission that QE failed. Yet negative rates are also based on thenotion that banks are liquidity-constrained.Central banks now want to force banksto lend their excess reserves by taxing these reserves.

Central bankers believe bankswill want to avoid having to pay for deposits at the central bank, and lendthosereserves.

Yet, this has backfired as well.

In Switzerland, where negative rates wereintroduced over a year ago, banks are holding more reserves than before.Whilethey accept to pay the tax, they have passed on these extra costs to borrowers byraising lending rates.

So negative rates have led to higher lending rates! Moreover,excluding real estate loans, lending activity to the private sector has actually gonedown, not up.

So like QE, negative rates don't seem to be working. And now, some very prominentpeople are promoting the next big idea: monetary financing, better known as "quantitative easing for the people."

It has been heavily promoted by Adair Turner, amember of the UK's Financial Policy Committee and popularized by Martin Wolf ofthe Financial Times.

Essentially, the central bank would simply print new moneyand finance all fiscal deficits. In some other versions, it would print money and giveit directly to households.

There is a common thread running through all these ideas: desperation. I havecalled this 'Hail Mary Economics.' Just recently Mark Carney warned: "The globaleconomy risks becoming trapped in a low growth, low inflation, low interest rateequilibrium."

The former Bank of England Governor, Mervyn King, also recentlysaid another financial crisis is "certain" if reforms are not implemented echoingsomething I wrote here in November 2014.

It's time to get rid of these bad economic models, and go back to the ones that haveworked well in the past. My own model tells me that monetary policy does not workat low interest rates, and that we must rely on fiscal policy.

To paraphrase a well-worn political expression, 'It's fiscal policy, stupid.'

Louis-Philippe Rochon isAssociate Professor, Laurentian University andCo-Editor, Review of Keynesian Economics.