Central Banks Launch Growth Mission With Arsenals Questioned
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Central bankers readying to fight another economic downturn are tossing hand grenades rather than firing bazookas.
Federal Reserve Chairman Jerome Powell and European Central Bank President Mario Draghi stand ready alongside many of their counterparts to cut interest rates to bolster the weakest growth in a decade and lackluster inflation. Yet they have little to work with and, perhaps more worryingly, what they do have lacks potency.
Expansions and price growth are flagging despite the easy money already sloshing around and further stimulus may do little to offset the trade war. Structural obstacles such as rising debt burdens, digital disruption and aging populations also work against looser 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.”
Political pressure is mounting on central banks to do more, led by a string of attacks by President Donald Trump on the Fed. Investors are also pressuring central banks to act while expressing concern about what they can achieve. $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.
“Cutting rates now makes sense given the softening activity,” said Janet Henry, chief economist at HSBC Holdings Plc. “No central banker wants to be held responsible for failing to be nimble enough to prevent an expansion from coming to a halt.”
While Henry warns there is a risk of inflating asset bubbles, Ethan Harris, head of global economics research at Bank of America Corp., said an advantage of easing now is to avoid a slump in markets which would drag down growth.
Central bankers maintain they are up to the challenge.
Powell told U.S. lawmakers last week that the U.S. economy is “in a very good place” and central-bank officials want “to use our tools to keep it there.” Draghi said last month that failing to act would mean “resignation, acceptance of defeat.” Bank of Japan Governor Haruhiko Kuroda recently told Bloomberg News he can deliver more big stimulus if necessary.
But more than 700 rate cuts worldwide over the past decade mean benchmarks are already around historical lows and there’s not much conventional ammunition left. The Fed’s benchmark, for example, is half the level it was at prior to past downturns.
Policy makers could still buy bonds again in the hope so-called quantitative easing caps bond yields and ignites investment. 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,” said Slok.
Monetary policy may also fail to counter the fallout from the trade war. Rate cuts will need time to take effect and then may not be enough to offset the demand shock if the clash between the U.S. and China worsens or spreads. The frictions may also dent the supply potential of economies which cheaper rates can’t do much about and may prove inappropriate if inflation spikes.
Tight labor markets pose another challenge. Even with unemployment falling to multi decade lows, wage gains have been muted. That’s stirred discussion around whether or not an assumed link between robust jobs growth and consumer-price growth through higher wages is broken.
Even if trade tensions pass, there are other reasons to doubt inflation will rebound regardless of what central banks do.
“I see three ‘Ds’ that make monetary policy less potent: debt, demographics and digitalization,” said Jerome Jean Haegeli, chief economist at the Swiss Re Institute in Zurich. “These are all structural factors that are here to stay.”
Since the financial crisis households, companies and governments have racked up record debts of $243 trillion. While they may welcome cheaper borrowing costs, those in hock might be more interested in paying that down debt than taking on new loans to spend.
Banks may also be reluctant to lend. At the ECB and BOJ, rates are already negative and further reductions would risk hurting lenders and leaving them even less likely to help companies and consumers.
Markus Brunnermeier, a professor at Princeton University, has warned of a “reversal interest rate’’ in which accommodative monetary policy turns contractionary because banks cease lending amid concerns about their equity positions or need to satisfy capital regulations.
Aging populations around the world will also mean less spending and more saving, stifling inflation. A new study of 21 economies by Oxford Economics Ltd. found a negative relationship between age and prices for most of the last 60 years.
On the technology front, increased automation of work will pressure wages and, in the long run, innovations such as digital currencies could make monetary policy less effective.
What Bloomberg’s Economists Say:
“Businesses will have to weigh the benefits of lower rates against the risk a Trump tweet could break supply chains or block market access. Fund managers will wonder what happens to markets when the limited space for rate cuts is exhausted. In both cases, those uncertainties will reduce the efficacy of easing.”
–Tom Orlik, chief economist at Bloomberg Economics
If central banks do fall flat, pressure will grow on governments to act, perhaps even in unison with monetary policy. The Bank for International Settlements recently urged politicians to “ignite all engines.” Citigroup Inc. economists estimate easier monetary policy without fiscal support will still mean advanced economies undershoot their inflation targets.
The mounting fear is economies could end up mimicking the recent experience of Japan, where stimulus repeatedly failed to power a sustainably strong expansion.
“While most would like to argue that they are not Japan, much of the developed West has indeed followed Japan’s path, with varying lags,” said Stephen Jen, who runs Eurizon SLJ Capital, a hedge fund and advisory firm.
— With assistance by Toru Fujioka, Zoe Schneeweiss, and Rich Miller
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