Blog Post

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.

By: Date: February 22, 2016 Topic: Global Economics & Governance

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

  1. unconventional monetary policy tools don’t have extreme downside risks
  2. central banks can control inflation using unconventional tools
  3. hitting inflation objectives may not translate into hitting growth objectives

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Dial N for NAIRU, or not?

What’s at stake: The concept of the NAIRU (Non-Accelerating Inflation Rate of Unemployment) has recently divided the minds in the economic blogosphere. We review the most important contributions on its usefulness, its shortcomings, alternatives and we discuss why it is such a contested concept.

By: Pia Hüttl Topic: Global Economics & Governance Date: May 22, 2017
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
DSC_0794

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The US and the productivity puzzle

What’s at stake: Productivity growth fell sharply following the global financial crisis and has remained sluggish since, inducing many to talk of a “productivity puzzle”. In the US, we may be seeing what look like early signs of a reversal. We review recent contributions on this theme.

By: Silvia Merler Topic: Global Economics & Governance Date: May 8, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The Trump tax cut

What’s at stake: on Wednesday, the Trump administration - now 100 days old - unveiled a draft tax plan including the intention to enact a radical cut to the corporate income tax, lowering it to 15 percent. While we are still missing details on how this and other measures would be implemented, we review some of the early reactions.

By: Silvia Merler Topic: Global Economics & Governance Date: May 2, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The decline of the labour share of income

What’s at stake: at odds with the conventional wisdom of constant factor shares, the portion of national income accruing to labour has been trending downward in the last three decades. This phenomenon has been linked to globalisation as well as to the change in the technological landscape - particularly “robotisation”. We review the recent literature on this issue.

By: Silvia Merler Topic: Global Economics & Governance Date: April 24, 2017
Read article More on this topic More by this author

Blog Post

Uuriintuya Batsaikhan

Embracing the silver economy

What’s at stake: The oldest human in known history was a Frenchwoman called Jeanne Calment who celebrated her 122nd birthday in 1997. Thanks to advances in technology and medicine humans living until 100, if not 122, might not be an exception in the near future. Ageing, while described as a looming demographic crisis, also offers a silver lining. Business in rapidly ageing societies is already adapting their strategies to navigate the “silver economy”. This blogs review looks at the implications of the silver economy on growth, productivity and innovation as well as the opportunities offered by the silver industry.

By: Uuriintuya Batsaikhan Topic: Global Economics & Governance Date: April 10, 2017
Read about event More on this topic

Upcoming Event

Oct
2
09:00

Europe and Japan: Monetary policies in the age of uncertainty

This event is co-organised by Bruegel and the Kobe University Graduate School of Economics.

Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Past Event

Past Event

Can EMU survive a multi speed Europe?

On 6 April Bruegel, as in previous years, hosted the presentation of the Euro Yearbook, a collection of experts’ insights on the construction of the European Monetary Union through 2016.

Speakers: Pablo Zalba Bidegain, Maria Demertzis, Fernando Fernandez, Javier Méndez Llera, Karl Pichelmann and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 6, 2017
Read article More by this author

Blog Post

OLYMPUS DIGITAL CAMERA

Is China’s innovation strategy a threat?

What’s at stake: A number of recent contributions accuse China of acquiring technology from abroad without respecting international rules. This blog reviews the current debate that focuses on China’s supposed push to modernise its industry and the challenges for advanced economies. By leapfrogging to high-tech manufacturing products, the strategy threatens the competitive advantage of the US and the EU. The international rules-based order is put to a test facing large-scale government support to high-value added sectors and anti-competitive behaviour.

By: Robert Kalcik Topic: Global Economics & Governance, Innovation & Competition Policy Date: April 3, 2017
Read article More on this topic More by this author

Blog Post

B Coeuré - photo

Central bank communication in a low interest rate environment

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at an event organised by Bruegel, Brussels, 31 March 2017

By: Benoît Coeuré Topic: European Macroeconomics & Governance Date: March 31, 2017
Read article More on this topic

Blog Post

Alicia García-Herrero

Who would bet on currency unions after EMU crisis?

The European Monetary Union (EMU) was founded with the idea that nominal convergence would bring real convergence, but structural differences between members have proven wide enough to generate lasting asymmetric negative shocks across the euro area.

By: Alicia García-Herrero and David Martínez Turégano Topic: Global Economics & Governance Date: March 29, 2017
Read article More on this topic More by this author

Blog Post

DSC_0794

Why was the last TLTRO take-up unexpectedly high?

The final round of TLTRO financing was an unexpected hit with euro area banks. The aim of the programme is to encourage banks to increase lending to the real economy. However, with many now expecting a hike in deposit rates, banks’ enthusiasm might be driven largely by the chance to make a profit from the cheap loans.

By: Justine Feliu Topic: European Macroeconomics & Governance Date: March 27, 2017
Load more posts