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 Global Economics & Governance Tags & Topics

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 Download PDF

Policy Contribution

screenshot-bruegel.org 2016-06-23 15-45-59European Parliament

The effectiveness of the European Central Bank’s Asset Purchase Programme

Since the end of 2014, inflation has been at or very close to zero. With very little ability to move the actual interest rate further into negative territory, the ECB has resorted to unconventional measures. The latest of these includes a programme to purchase corporate bonds, which started on 8 June 2016.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance, European Parliament, Parliamentary Testimonies Date: June 23, 2016
Read article More on this topic More by this author

Blog Post

MariaDemertzis1 bw

Corporates are responding to the new ECB corporate sector purchase programme

We have observed a sharp increase in corporate bond issuance following the ECB’s announcement in March this year, but it is too early to see the effects on investment by non-financial corporations.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 16, 2016
Read article

Blog Post

MariaDemertzis1 bw

Are central bank(er)s still credible?

Both the Fed and the ECB have managed to remain credible since the financial crisis, but their credibility levels have evolved differently. Since inflation in the US and the euro area has been similar in the past 8 years, the difference in the way that credibility has evolved is the result of the different macroeconomic policy mix applied.

By: Maria Demertzis and Nicola Viegi Topic: European Macroeconomics & Governance Date: June 14, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The cyclicality of structural reforms

What’s at stake: In line with the crisis-induced reform hypothesis, European countries have since 2010 enacted unpopular reforms in labour market regulation and social welfare systems.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: June 13, 2016
Read article More on this topic More by this author

Blog Post

Alvaro Leandro

The use of ECB liquidity

The Eurosystem’s regular open market operations consist of one-week liquidity-providing operations (MROs), and three-month liquidity-providing operations (LTROs). We have updated data on the use of these operations by country.

By: Alvaro Leandro Topic: European Macroeconomics & Governance Date: June 9, 2016
Read article More on this topic

Blog Post

Schoenmaker pic
Nicolas Véron

European banking supervision: compelling start, lingering challenges

The new European banking supervision system is broadly effective and, in line with the claim often made by its leading officials, tough and fair, but there are significant areas for future improvement.

By: Dirk Schoenmaker and Nicolas Véron Topic: Finance & Financial Regulation Date: June 8, 2016
Read article Download PDF More on this topic

Blueprint

cover bp xxv

European banking supervision: the first eighteen months

The Blueprint provides a review of the first 18 months of European banking supervision. It reviews the overall situation and the situation in a number of euro-area countries. It provides important insights into the start of a new policy regime that involves profound change for the European banking landscape

By: Dirk Schoenmaker and Nicolas Véron Topic: Finance & Financial Regulation Date: June 8, 2016
Read article More on this topic More by this author

Blog Post

Uuriintuya Batsaikhan

Brexit and the UK’s Euro-denominated market: the role of clearing houses

Clearing houses in the UK operate an extremely sizable market in euro-denominated transactions. However, even though the numbers are big in value terms, in substance, clearing houses shifting to the continent will not make a big difference to the UK economy and employment. Arguably, there is a case for the ECB to claim that euro area business of clearing houses be relocated.

By: Uuriintuya Batsaikhan Topic: European Macroeconomics & Governance Date: June 7, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The new Washington Consensus

What’s at stake: Since 2008 the IMF has been at the forefront of a revaluation of the orthodox policy toolbox. While the majority of policies that constituted the old Washington Consensus remain in place, the consensus has moved on financial openness and fiscal consolidations.

By: Jérémie Cohen-Setton Topic: Global Economics & Governance Date: June 3, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The abandonment of counter-cyclical fiscal policy

What’s at stake: The reluctance to use fiscal policy as a stabilizing tool in the current deflationary environment has been puzzling to many and a number of authors are now putting forward possible explanations.

By: Jérémie Cohen-Setton Topic: Global Economics & Governance Date: May 30, 2016
Read article Download PDF More on this topic More by this author

Essay / Lecture

Cover frieden

Lessons for the euro from early US monetary and financial history

In this essay, Jeffry Frieden looks at the process of creating a monetary union in the United States and draws lessons for the EU.

By: Jeffry Frieden Topic: Global Economics & Governance Date: May 25, 2016
Read article More on this topic More by this author

Blog Post

Marek Dabrowski

Core and periphery: different approaches to unconventional monetary policy

Compared with the ‘core’ of the world economy, emerging markets have limited room for manoeuvre when it comes to applying unconventional monetary policy measures.

By: Marek Dabrowski Topic: Global Economics & Governance Date: May 24, 2016
Load more posts