This past week has only reinforced the idea that central banks are becoming increasingly active in trying to halt the slide towards stagnation in several major economies. This is because their nations’ fiscal policy remains jammed on austerity mode, whether it be through political gridlock (America), ideological stubbornness (Britain) or a combination of the two, paired with the fear of implosion (the Eurozone). Reforming monetary policy has become the last resort in an attempt to kick start growth, and central bankers are trying to embrace this change.
The Bank of England’s recent monetary direction has often been inventive. With a renewed remit, it has increased powers and has upcoming change of governor. This looks set to continue.
While Paul Tucker’s radical suggestion of negative interest rates was more idle speculation than substantive strategy, the Bank has been keen to turn to unusual methods. Certainly, there has at least been a bid to improve the Bank’s reputation for closed-mindedness; it was accused of being ‘behind the curve’ before the crisis. Yet some of the ideas to increase bank lending have flopped, Funding for Lending being one. What is important is that the Bank is more doveish in outlook, even under Mervyn King, a notable pre-crisis hawk.
Even though no further action was taken by the Bank at the end of last week, since 2009 the reversal in tone of an institution infamous for its insularity and rigid chain of command has been pleasantly surprising. Although given the severity of the crisis, one could argue that they had no choice. The remit change hopefully means that the Bank will be more mindful of growth even after the recovery. More importantly, those at Threadneedle Street should understand that hitting 2% inflation in ‘normal times’ is not the be all and end all for macroeconomic prosperity.
In Autumn last year the Federal Reserve in the United States made an explicit pledge to maintain an expansive monetary policy for a few years more, even if the economy were to pick up strongly. More recently, there had been talk of reducing asset purchases, but the poor recent jobs figures are likely to cause them to reconsider. At the moment it is buying $85 billion of longer-term government debt and mortgage-backed securities a month. The Federal Reserve was one of the first major banks to accept that the transmission mechanism was broken (its head, Ben Bernanke, is an expert on Depression Economics) and continually took aggressive action, for instance, through holding the federal funds rate at virtually zero until 2015.
The Bank of Japan has broken even more radically from its recent convention. On Thursday the BOJ announced that it was increasing the level of asset purchasing by $520bn a year, equivalent to 10% of GDP. It is unclear if that will provide a cure. If its monetary easing programmes in the past have taught us anything, it is that when the transmission mechanism of monetary policy is as dysfunctional as Japan’s it can be hard for the actions of central banks to be felt in the real economy. In Britain, it was felt a significant minority of QE money ended up abroad or speculated. Despite this, the BOJ has intentionally been more expansive than the markets were expecting. It is likely to have been designed as a confidence boosting measure by showing that the bank is being proactive in trying to break the cycle Japan finds itself in, similar to Mario Draghi’s pledge to do ‘whatever it takes’ to save the Eurozone.
The BBC’s economics editor, Stephanie Flanders, once quoted the US comedian Mitch Hedberg to explain how this particular mechanism of QE works, suggesting ‘My fake flowers died because I forgot to pretend to water them’. Indeed, a criticism levelled at Mr Kuroda’s predecessor was that he consistently balanced asset purchasing with suggestions that it was not enough to curb deflation.
Three of the major central banks have been radical in their outlook. The European Central Bank, on the other hand, has often seemed too cautious in its approach. In mitigation, it probably has a more difficult job. It is hard to see how monetary policy in Greece should be similar to that of Finland. Even so, with its economic prospects arguably the harshest of the four it still has the highest interest rate, providing no relief for the peripheral economies having to enforce large cuts to public spending.
Perhaps it is a little unfair to criticise the ECB, after all, it does have the added responsibility of trying to hold the Euro together. In this respect, a lot of its actions have been successful, especially last year’s promise to buy ‘limitless’ amounts of periphery economy sovereign bonds last year; it resulted in a drop in their cost of borrowing.
These tactics indicate that the major developed economies are still in trouble. No amount of exultation in stock markets can disguise poor consumer and business confidence data, or low growth. Central banks turn to unconventional measures because no traditional form of monetary policy can feed its way through to the real economy. They are probably more than aware that QE often leads to increased speculation and risks causing asset bubbles, but the positives outweigh the side effects. Furthermore, the time scale of their policies hints at the length of the recovery ahead; their governors have become very good at pledging to do the same thing for a very long time. One would hope that the idea of years of ‘limitless’ support would eventually pick up confidence in the real economy.
There are some who predict that splurging trillions of dollars on asset purchasing will end in tears, but it can sometimes be difficult to see where these commentators are coming from. One realistic problem is that monetary expansion will lead to currency devaluations, meaning yet more so-called ‘currency wars’, where if every country attempts to devalue, no individual currency gets relatively cheaper and everyone ends up worse off than if they had not pursued the tactic. The head of the World Bank Jim Yong Kim has suggested that this consequence of QE is permissible as long as the main goal is to boost output and employment.
What is clear is that in the short-to medium term, this new world of central banking will persist. It will be interesting to see whether this doveish evolution brought on by difficult times will continue when things get better. Depressingly, it seems as if that scenario is too far in the future for the question to be raised.
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