The impotency of central banks
What’s at stake: The negative market reaction to the latest efforts to provide further monetary stimulus has generated an important discussion on whether central banks have lost credibility in their abilities to fight downside risks and shore up economies.
From potency to impotency
Leo Grohowski writes that central bank policies and the uncertainty around their effectiveness is the big macro concern right now. William Watts writes that with central banks continually undershooting inflation targets despite extraordinarily loose policy, there are growing fears that the ability of monetary policy to affect the real economy has been impaired. Amid a growing realization that central banks’ powers are on the wane, investors are rushing for havens.
Bill Gross writes that “how’s it workin’ for ya?” – would be a curt, logical summary of the impotency of low interest rates to generate acceptable economic growth worldwide. John Plender writes that arguably now the most important question in global finance concerns the limits to the power of central banks. Since 2009 investors have staked their all on the notion of central bank potency. Last week the doubts set in seriously, contributing not a little to the market turmoil.
Zero Hedge writes that first, it was the Bank of Japan (BOJ)’s utter collapse from omnipotence to impotence. Then came the collapse of The Fed’s credibility in the short-term…. and the longer-term. And now it is the turn of Mario Draghi’s ECB to face total failure, as the European banking system – the prime beneficiary of “whatever it takes” – has crashed back to pre-Draghi levels.
The Bank of Japan episode
Joseph Gagnon writes that on Jan. 29, the BOJ announced a complicated program to pay different rates of interest on tranches of deposits that banks hold with the BOJ. Beyond a certain point, any additional money deposited at the BOJ will earn a negative rate of interest. Financial markets quickly reacted positively: Real bond yields fell, the yen fell, and stock prices rose. But much of these gains were erased in subsequent days, probably because markets came to believe the effects of the new policy would be small.
Tyler Durden writes that not only are words not enough to create the only effect that Central Banks care about but their actions are now worse than doing nothing. Takashi Nakamichi writes that the goal was to bring down interest rates generally, including long-term rates charged for home loans. The central bank hoped to augment its existing easy-money policy, which has pumped ¥80 trillion ($700.8 billion) of cash annually into the economy by purchasing government bonds. Shortly after the move, global markets swooned and the yen, seen as a haven in times of trouble, rose against the dollar, threatening the profits of Japanese exporters.
Negative rates: conventional or unconventional?
Narayana Kocherlakota writes that negative rates will only be an effective form of stimulus if they are treated as being fully conventional, as opposed to an unconventional emergency measure. Treating these measures as “break the glass” instruments of policy robs them of their effectiveness because every time you bring them out, you will be signaling that things are going very badly. You want to treat your entire policy tool kit as conventional. For example, on negative interest rates, it should be made clear that there is no zero lower bound, and you should communicate ahead of time how low you are willing to go.
Narayana Kocherlakota writes that to avoid a BoJ-mess, the Federal Reserve should immediately begin to communicate more positively about negative rates. Given the apparent distaste of the BoJ for negative rates, the decision to go negative seemed to carry a latent message that the BOJ had lost at least some confidence in the efficacy of expanding its quantitative easing program. In early December 2015, Governor Kuroda said that the BOJ was not intending to use negative rates. On January 21, 2016, Governor Kuroda told the Japanese parliament that the BOJ was not planning to go negative, pointing to unstated “cons” of such a move. Eight days later, the BOJ did in fact go (slightly) negative.
Jared Bernstein writes that central banks using negative rates are implicitly admitting that they’ve lost control of inflation. The negative rate that central banks would much prefer to be operative is the real rate, i.e., the nominal rate minus inflation. But both because of their own hawkery on this front – great devotion to anchoring price growth at a low inflation target of 2% – along with global deflationary trends in commodities, they’ve been missing their inflation targets on the downside for years. And that’s propped up real rates relative to where they’d be in more normal inflationary times.
Lessons from unconventional monetary policies
Joseph Gagnon writes that the paradox of quantitative easing is that central banks that were slowest to engage in it at first are being forced to do more of it later than those central banks that embraced it earlier. If the BOJ does not move boldly now, it will have to do even more later.
Noah Smith writes that the years 2008 through 2014 saw some monetary experiments that were unprecedented – a long period of zero interest rates, several versions of quantitative easing, new types of forward guidance and the payment of interest on excess reserves. Although these experiments give us a lot of new information, the lessons are not clear, and continue to provoke spirited debate. No one really knows what is going on with monetary policy right now. No one knows what the Fed is really trying to accomplish, or what it can accomplish, or how to go about accomplishing it.
Narayana Kocherlakota writes that Noah Smith’s article highlights the following question: Is the long-term use of expansionary monetary policy (like low interest rates or QE) actually causing inflation expectations and potential growth to decline? It’s a big one and the available macroeconomic data doesn’t provide as sharp an answer as I would like to this question. But we shouldn’t allow that important remaining question to obscure the three important lessons from the FOMC’s monetary policy experiments. In particular, that
- unconventional monetary policy tools don’t have extreme downside risks
- central banks can control inflation using unconventional tools
- hitting inflation objectives may not translate into hitting growth objectives
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