Central bankers fear threat of low-growth rut
Without parallel action by lawmakers, economies could still be left vulnerable
As the world’s central banking elite gathered at Jackson Hole, Wyoming, Janet Yellen provided the assurances that many of the attendees craved.
Official interest rates may remain stuck at low levels, but the US central bank will not find itself out of weaponry if a new recession unexpectedly strikes, the Federal Reserve chair said in her set piece speech on Friday.
But, beneath the surface at the Kansas Fed’s annual symposium, many economists remained anxious. Their meetings highlighted worries about whether western central banks have sufficient scope to galvanise growth without help from other branches of government — and concerns over expectations piled on officials’ shoulders as some experiment with radical measures such as negative interest rates.
Eight years after the crash, major economies including the US are stuck with sub-target inflation, ultra-low rates, and economic growth that remains pedestrian. Without action from lawmakers in countries including the US, where Congress has a history of bitter budgetary deadlocks, they could be trapped in a low-growth rut that leaves them hugely vulnerable when the next downturn comes.
“Central banks still have arrows in their quiver [although] they may not be as effective as they were before the crisis,” says Randall Kroszner, a former Fed governor who is now a professor at the University of Chicago Booth School of Business. However, “many central banks are being asked to do things they simply can’t do. Central banks can try to fight deflation. Central banks can’t simply create growth.”
Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said in an interview that she believed the US central bank can rely on previously proven tools such as quantitative easing and forward guidance, on top of rate cuts, to reverse a future downturn. While colleagues including John Williams of the San Francisco Fed have floated the idea of lifting the Fed’s 2 per cent inflation target, she says she is happy with it where it is.
But Ms Mester added: “I think we would have a better economy, a stronger economy, if we were able to have fiscal policy together with monetary policy — especially for these things which are about the long-run potential growth rate of the US economy.”
Deep into her speech in Wyoming Ms Yellen herself mentioned the need for larger so-called automatic stabilisers in US budgetary policy, which would help weigh against future recessions, as well as greater support for state and local governments. Unemployment benefits and taxes can serve as such stabilisers, dampening the impact of swings in the economy as a whole.
But amid rancorous political pressure on the Fed from both sides of the partisan divide and an election looming, Ms Yellen shows no signs of embarking on a full-blooded campaign of budgetary reform.
Instead she and other central bankers focused their debate in Jackson Hole on optimising tools in their own arsenals. In that regard the Fed chair’s speech was as notable for what it failed to mention — negative rates — as for what it did.
Central banks in Europe and Japan are among those experimenting with pushing rates below zero in an effort to bolster their economies and inflation.
But US policymakers question how well negative rates would translate to their complex financial system, heavily reliant as it is on non-bank players including money market mutual funds. Ms Mester says she would oppose taking the federal funds rate into negative territory. Other Fed officials are also sceptical.
“Negative rates are certainly getting mixed reviews around the globe,” said James Bullard, the St Louis Fed president. “I don’t think it is very likely in the US.”
Outside the US there are mixed experiences. The Bank of Japan is still grappling with depressed growth and inflation despite its addition of negative rates to its quantitative easing scheme. Big financial groups including pension funds and insurance companies are wailing about the damage to their returns from the lower-for-longer rates environment
The European Central Bank believes it is seeing beneficial results from its negative rates policy, but Benoît Cœuré, a member of the ECB’s executive board, said in a Jackson Hole speech that unconventional policies can give rise to unwanted outcomes. “We cannot rule out a situation where the side effects are such that the negative consequences prevail,” he warned.
Whether negative rates are useful can depend heavily on an individual financial system. Markus Brunnermeier, a professor at Princeton University, has been looking at the possibility that as rates are cut they can become counter-productive because of the way they interact with the banking system and local regulation.
His advice to central bankers: “Yes you can go negative, but check your banking system before you do it, and don’t do it too long, and do it in the right sequence.”
Peter Henry, the dean of New York University’s Stern School of Business, says central bankers still have the tools to provide a floor under the economy, but cannot provide a springboard for growth in the absence of action by lawmakers in areas such as immigration, trade and fiscal reform. “Negative real rates have not yet spurred a recovery in investment. So one has to ask the question is there something else standing in the way,” the economist says.
Agustín Carstens, the governor of the Bank of Mexico, says other branches of governments have to step forward. “What we are getting out of these discussions is that we are sort of reaching the limits. In many countries monetary policy activism has run its course.”