Central Banks and the New Abnormal

Markets fret as they forget what normal policy looks like.

The president of the European Central Bank, Mario Draghi, during a news conference in Tallinn, Estonia, on June 8. Photo: Bloomberg News

This week’s gyrations in currency and bond markets are best understood as the triumph of fear over experience. It’s as if markets think central banks are really in danger of returning to more normal policies.

The euro jumped 1.4% against the dollar Tuesday after European Central Bank President Mario Draghi said “all the signs now point to a strengthening and broadening recovery in the euro area.” Never mind that it came in the context of a speech in which Mr. Draghi argued that the ECB should continue doing more of the relatively easy monetary policy he says is working. Markets interpreted the comment as a sign that the ECB may soon start dialing back on its negative interest rate and €60 billion-a-month ($68.16 billion) bond purchases, or quantitative easing (QE).

Bank of England chief Mark Carney set off a similar jump in the pound on Wednesday when he suggested Britain’s central bank might at some point sort of think about almost raising interest rates—if the bank no longer feels it needs to make trade-offs between economic growth and its inflation target. To be exact, what he said was: “Some removal of monetary stimulus is likely to become necessary if the trade-off facing [policy makers] continues to lessen and the policy decision accordingly becomes more conventional.” Got it?

You can’t fault investors for intensive tea-leaf reading of otherwise anodyne comments like these. Given the size of the bond portfolios central bankers have amassed since the crisis, investors are understandably curious about any clues to what central banks will do next.

As a result, markets are overlooking how little central bankers are actually saying. Mr. Draghi’s subordinates took to the media Wednesday to point out he hadn’t meant monetary normalization would come immediately. But what if he had? Even in that case, “normal” would be a very gradual reduction in a quantitative-easing bond portfolio that didn’t exist before March 2015.

And the negative interest rate that was once considered a crisis measure but has hung on for three years? A return to zero, let alone the ECB’s pre-2008 rates of between 1% and 3%, remains years off. The same is true in Britain. If the BOE ever does move from its current benchmark rate of 0.25% back to the 3% to 6% range before the panic, it will take years.

The U.S. Federal Reserve, which now is leading the way on unwinding crisis policies, is doing so very slowly despite eight years of economic growth. If the Fed does make it to 2% by the end of next year from 1% to 1.25% today, the fed-funds rate would still be well below its level during the late 1990s boom or its pre-2008 maximum.

There’s nothing tight about any of this. Markets have simply forgotten what normal monetary policy looks like. This poses a dilemma for central bankers, as Mr. Draghi noted when he warned that, as the economy improves, policies that today offer the right level of stimulus might become too accommodative. It’s hard for central bankers to adjust when any move to make policy slightly less easy is interpreted as a move to make it much tighter.

Then again, central bankers have themselves to blame. As policy becomes further divorced from definable metrics such as inflation—which already suggests a need for tightening in Britain and the eurozone—central bankers struggle to explain whether and when they might adjust policy.

Markets have learned that central banks can be bullied into keeping the punch bowl on the table a little longer, as with the taper tantrum that delayed the Fed’s slow withdrawal of QE by a few months in 2013. As this week has shown, the result could be a bumpy exit from crisis-era policies that central bankers increasingly recognize are no longer suitable.

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