One of the biggest challenges facing central banks in this increasingly post-myth environment is that they have to deal with the consequences of those past myths. Not all that long ago, it was widely believed that a central bank just did what it wanted to do, and that was the end of all discussion. If the Federal Reserve wanted to target a specific money rate, it did and the money rate dutifully obeyed.

At the height of monetary policy legend in the late 1990’s, this precision and ability was extrapolated into the real economy. If the “maestro” wanted the federal funds rate at X, the federal funds rate would not only be at X it would also be the best possible X which created the so-called Great “Moderation.” So powerful was monetary policy that it was thought able to accomplish so much by actually doing what was really so very little.

The events starting in August 2007 brought about a fly in the ointment, one that over the past almost ten years has been revealed to be wholesale flaws rather than the minor, temporary irritation of a bug. The “rising dollar” finally thrust these distinctions into the spotlight, for it was very easy to see, at long last, the great contradiction between what QE was supposed to have been and what was clear, global illiquidity traced to “dollars.” The basic idea of QE as it was sold to the public, however, was as if the “maestro” was still at work.

That wasn’t the start of the Fed’s trouble, however, as long before then questions had arisen about defining these terms. As I have written for years, if there had to be a second QE at such an early stage in 2010 there was everything wrong with not just the first but what QE is at least as it relates to the real economy in far simpler terms than the mess brought out by closer examination of wholesale money and banking. Even Janet Yellen in one of her first major policy speeches in July 2014 recognized these “doubts”, suggesting that even the Fed’s policy would in the future be less money, or at least bank reserves, instead being shouldered more and more by the supervisory role:

In my remarks, I will argue that monetary policy faces significant limitations as a tool to promote financial stability: Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment. As a result, I believe a macroprudential approach to supervision and regulation needs to play the primary role.

This view is not one exclusively of the US central bank. It has become, or has been to some degree for some time, a central element. In many places it has yet to be fully tested, but in China macroprudential policy has been applied in what looks to be the PBOC’s attempt to straddle both sides of Chinese reality. In many ways, their situation must feel to them something like a paradox, as monetary policy attempts to simultaneously “stimulate” a dangerously flagging economy while at the same time keep its bubbles from spiraling out of control (in either direction).