Central bankers around the world are asking for help in staving off a global economic downturn, but will politicians will respond to the call quickly enough?
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Central banks around the world are trying to stave off an economic slowdown on a global scale—but they can’t do it alone.
The main role of central banks are to stabilize currency, keep the economy moving along in step with inflation through sound monetary policy. In recent years, monetary policy has been loosened to ease the flow of money, but there’s a limit to the impact that monetary policy can have. Currently, obstacles such as rising debt, aging populations, and even the trade war are having an impact on the effectiveness of a loose monetary policy.
“There are limits on what further monetary easing can achieve,” Reserve Bank of Australia Governor Philip Lowe said in June. “You still get benefit from it, but there are limits.”
This isn’t just limited to the U.S. Investors and politicians worldwide are pressuring central banks to do more to continue economic expansion, while simultaneously expressing concern about the limits of their policies themselves. That pressure is intensifying; even though $13 trillion of bonds now boast yields below zero, yet monetary-policy impotence was a major worry of money managers surveyed last month by Bank of America Corp.
Ethan Harris, head of global economics research at Bank of America Corp., told Bloomberg that an advantage of easing rates now is to avoid a slump in markets which would drag down growth.
Central bankers want to keep economies moving and have expressed a desire to do so, pledging to use whatever tools they have available. The problem is that rates are already at historic lows, and there isn’t much more room to go in that direction. For context, the Fed’s benchmark is at half the level it was prior to past economic downturns. At the European Central Bank and the Banks of Japan, Sweden, and Switzerland, rates are already in negative territory.
At the Group of Seven summit this week, finance ministers and central bankers plan to address risks in the global economy that might affect global economic growth, and explore the balance of monetary and fiscal policy moving forward.
“Monetary policies can do a lot but they can’t do everything confronted with the slowdown and they can’t perform miracles,” Bank of France Governor Francois Villeroy de Galhau told Bloomberg after the meeting. “It is essential that there are also the other instruments of economic policy: structural reforms, and of course fiscal policies where there is possible space.”
Fiscal policy should be created with flexibility and growth in mind, and able to rebuild buffers where needed, according to a summary of the talks prepared by the French G-7 presidency. “Monetary policy will continue to support economic activity, while remaining mindful of financial stability and recognizing that monetary policy alone cannot address all economic challenges.”
Pierre Moscovici, the European Union’s economic and monetary affairs commissioner, told Bloomberg Television that it’s necessary to reflect on fiscal policy as well.
“It’s high time that we build the right policy mix because what we see today is a slowdown in the economy everywhere,” he said.
At a dinner celebrating the 75th anniversary of the Bretton Woods conference that led to the creation of the World Bank and International Monetary Fund, U.S. Fed Chairman Jerome Powell said that the central bank is “carefully monitoring” downside risks to U.S. growth and “will act as appropriate to sustain the expansion,” reiterating concerns last week that cemented expectations for an interest-rate cut later this month.
Powell also mentioned the importance of international linkages among economies and their common challenges. He specifically focused on low rates of inflation and low interest rates that are likely to hit zero again the next time central banks need to stimulate their economies.
“This proximity to the lower bound poses new complications for central banks and calls for new ideas,” Powell said, suggesting that central banks should continue to look beyond unconventional tools, such as bond buying and forward guidance, that they used in the last crisis. “We must continue to assess additional strategies and tools to bolster our economies and meet our inflation and employment mandates.”
Unconventional tools may be on the table again, but Deutsche Bank AG chief economist Torsten Slok analyzed studies of such programs and found they generally concluded that the announcement effect had the biggest impact on long rates and inflation expectations.
“Given the current level of inflation expectations and the current level of rates, doing QE again is not going to create the same surprise effects,” Slok told Bloomberg.
If the trade dispute between the U.S. and China continues, the effects may spread well beyond the scope of monetary policy. Rate cuts, for example, wouldn’t have an immediate effect, and the situation might also have a negative impact on the supply potential of economies that won’t be helped by cheaper rates if inflation rises. Even if trade agreements were made tomorrow, there’s no guarantee that inflation would rebound anyway.
“I see three ‘Ds’ that make monetary policy less potent: debt, demographics and digitalization,” Jerome Jean Haegeli, chief economist at the Swiss Re Institute in Zurich, told Bloomberg. “These are all structural factors that are here to stay.”
Consumer spending is up—and so is debt for consumers, companies, and governments, to the tune of $243 trillion. It’s cheaper to borrow money, but securing more loans isn’t an attractive option for those carrying an already heavy debt burden. Unemployment is near historic lows but wage gains are conservative, at best, and other pressures on wages, such as an aging population, increased automation, and digital currencies could make monetary policy less effective overall.
Policymakers are also paying attention to emerging markets; South Africa was the latest player to cut interest rates, joining the Bank of Korea and Indonesia, which cut rates for the first time in more than two years in order to boost its economy.
“We are seeing political risks rising everywhere, so addressing the lack of growth that benefits all is quite urgent,” said Laurence Boone, chief economist at the OECD told Bloomberg. “That cannot be achieved only through monetary policy.”
