Since the start of the global financial crisis last August, monetary policy has been remarkably ineffective. The US Federal Reserve has cut short-term rates by a cumulative 225 basis points since then. Yet, borrowing costs for US consumers and companies have actually gone up. While the European Central Bank has stoically kept short-term interest rates at 4 per cent, rates charged to consumers and companies have increased.

So have bond spreads. On Friday, the spread between Italian and German government bonds widened to more than 70 basis points. In other words, the Italian government has been subject to an effective interest rate increase of more than 50 basis points during the past year, while the German government has not. While Italy has its share of problems, it is clearly no more likely to default today than it was a year ago. For as long as this financial crisis persists, interest rates will be determined by toxic market conditions, not central bankers. Among the various channels through which monetary policy affects the real economy, the credit channel is one of the most important. If real-world interest rates are determined independent of a central bank’s monetary policy, the effect of monetary policy on economic growth is correspondingly reduced.