Monetary policy does work, as Japan and the US prove

Last month - just a few days before the European Central Bank announced its intention to initiate quantitative easing - I attended a seminar in Geneva with international journalists, policymakers and investors. The discussions there, much like those in Japan before Prime Minister Shinzo Abe launched his groundbreaking economic reform strategy in 2012, reflected an inadequate understanding of unconventional monetary policy's transformative potential.

Indeed, at the seminar, European economists and journalists - especially the Germans - adopted a dismissive tone. "Monetary policy's power is limited, particularly when the interest rate is so low," some said.

This and other statements were somewhat surprising, given the progress that Japan has been making on the back of its ongoing strategy based on quantitative easing. Clearly, many in Europe lack an understanding of the history and significance of so-called Abenomics.

In 2001, the Bank of Japan was struggling to find ways to help the economy escape recession. Having already reduced the target short-term interest rate to very close to zero, it turned to open market operations - specifically, purchasing long-term government bonds and increasing bank reserves held at the Bank of Japan - to increase the money supply and reduce long-term interest rates.

But the BOJ's attempt at quantitative easing proved to be too little too late, and no recovery materialised. Ben Bernanke, then the chairman of Princeton University's economics department, took note of this failing, declaring that the BOJ should pursue a more aggressive monetary policy.

When the US investment bank Lehman Brothers collapsed in 2008, triggering a global financial crisis, Bernanke - who had become US Federal Reserve chair - took his own advice, instituting a bold quantitative easing programme to revive America's moribund economy.

Japan, by contrast, hesitated to expand its money supply substantially, leaving the yen's exchange rate against the US dollar to appreciate and causing gross domestic product growth to decline further. In 2009, Japan's economy was performing at 8 per cent below potential, even though its financial system was sound. In short, the Japanese economy suffered far more than the US economy.