Without structural reform, the next economic crisis is just around the corner

The world economy is in the grips of a dangerous delusion. As the great boom that began in the 1990s gave way to an even greater bust, policymakers resorted to the time-worn tricks of financial engineering in an effort to recapture the magic. In doing so, they turned an unbalanced global economy into the Petri dish of the greatest experiment in the modern history of economic policy. They were convinced that it was a controlled experiment. Nothing could be further from the truth.

The rise and fall of post-second-world-war Japan heralded what was to come. The growth miracle of an ascendant Japanese economy was premised on an unsustainable suppression of the yen. When Europe and the US challenged this mercantilist approach with the 1985 Plaza Accord, the Bank of Japan countered with aggressive monetary easing that fuelled massive asset and credit bubbles.

The rest is history. The bubbles burst, quickly bringing down Japan's unbalanced economy. With productivity having deteriorated considerably, Japan was unable to engineer a meaningful recovery. In fact, it still struggles with imbalances today.

Despite the abject failure of Japan's approach, the rest of the world remains committed to using monetary policy to cure structural ailments. The die was cast in the form of a seminal 2002 paper by US Federal Reserve staff economists, which became the blueprint for America's macroeconomic stabilisation policy under US Federal Reserve chairs Alan Greenspan and Ben Bernanke.

The paper's central premise was that Japan's monetary and fiscal authorities had erred mainly by acting too timidly. Bubbles and structural imbalances were not seen as the problem. Instead, the paper's authors argued that Japan's "lost decades" of anaemic growth and deflation could have been avoided had policymakers shifted to stimulus more quickly and with far greater force.

If only it were that simple. In fact, the focus on speed and force has prompted an insidious mutation of the Japanese disease. The liquidity injections of quantitative easing (QE) have shifted monetary-policy transmission channels away from interest rates to asset and currency markets.

But fear not, claim advocates of unconventional monetary policy. What central banks cannot achieve with traditional tools can now be accomplished through the circuitous channels of wealth effects in asset markets or with the competitive edge gained from currency depreciation.