World central banks are pushing on a string

• Central banks' signals ignored by the markets
  

• Might this be a broad-reaching paradigm shift?
  

• Money must be diverted to consumers to encourage spending
  

• Helicopter money or tax breaks could be the solution

The last few weeks have been an eye-opener for equity and currency markets as we have seen the market largely ignoring loud and clear signals from the major central banks. The European Central Bank made it very clear, starting more than a month ago, that the market should not doubt its willingness and ability to bring further policy easing to the table should conditions warrant. This message has failed to see more than a mere bounce in confidence that has since faded, such that we’re now back to trading near the lows for the year in European equities. The euro exchange rate, meanwhile, remains stuck in the recent range despite this likely warm-up for the ECB’s QE2.

Part of the reason for the lack of a stronger reaction to the downside in the EURUSD exchange rate from the ECB rhetoric was yet another dovish downshift at the September 17 Federal Open Market Committee announcement. There, the Yellen Fed took the dramatic step of introducing global considerations into its latest monetary statement in a clear tilt toward dovish caution. To round things off for the major central banks, a Reuters article last week suggested the Bank of Japan was considering an “overhaul” of its policy mix, as there hasn’t been enough traction on raising inflation. And the reaction in the Japanese yen to this? A shoulder shrug, if that.

Something is clearly changing here, and we may be headed for a paradigm shift here in which the market largely stops reacting to the drivers that provided every swing in asset markets and currencies in the years since the global financial crisis.

And if the world shows signs of tilting into zero growth or recessionary conditions again, it is clear that business as usual from the central banks will not help market confidence – nor the economy. What then?

If central banks want to bring back real demand in the economy and sustained inflation, they’ll need to print vastly larger piles of money – but this time, the printed money will need to be placed directly in consumers’ hands, rather than wasted on buying financial assets. This could be done by handing out cash in “helicopter money” fashion, or through massive tax breaks, in which the fiscal hole is plugged by the central bank. Either way, such a policy mix is currently a political taboo as it is seen as beyond the central bank’s mandate – such power would indeed require the collusion between the fiscal authority residing with the government and the supposedly independent central banks.

Simply put, central bank policy innovation is finished within the current paradigm. From here, the world’s politicians are about to find themselves in the policy hot seat again for the first time in more than five years – five years of a holiday in extend-and-pretend land bought and paid by the central banks. The transition to this recognition will likely mean tremendous market volatility.