It is often said that that the definition of insanity is doing the same thing over and over and expecting a different result. This appears to be a lesson that central bankers have been unable – or unwilling – to grasp.
Since the depths of the financial crisis in 2008, global monetary policymakers have pulled out all the stops to stave off disaster. These have included lower rates / zero rates / negative rates, forward guidance, Operation Twist, quantitative easing, funding for lending schemes, and now the possibility of “helicopter money.”
To be sure, central banks should be applauded for their creative thinking and flexible use of monetary policy tools when the global economy went on life support. While impossible to prove, it could certainly have been worse had they not acted so decisively. Whether it was the Bank of Japan’s “kitchen sink” approach, Mario Draghi’s “whatever it takes,” or the Federal Reserve’s “open mouth” policy, those extraordinary actions sent a strong message. A message that was powerful enough to change sentiment at a time when it was sorely needed.
What Comes After “Extraordinary”?
Today however, that same message may be doing more harm than good. Although sub-par, the global recovery/expansion is entering its eighth year. In this environment, extraordinary monetary policy seems disconnected from a world that is growing slowly but is hardly in crisis. Consumers and businesses may not understand the technical nuances of negative rates or helicopter money, but they recognize that extreme policies could only be justified by an extremely dire outlook. This disconnect doesn’t send consumers to the mall or encourage CEOs to invest in capital projects. After eight years, policies that once boosted confidence are now undermining it – diluting or possibly offsetting the very benefits that low rates were designed to deliver.
The Side Effects
If extraordinary policy is now undermining confidence, is it time for a change? Normalizing monetary policy obviously comes with its own risks: Raising interest rates or unwinding asset purchases could further slow the global economy and maybe even cause the next recession. While we acknowledge this risk, we believe central banks have reached a tipping point where the negative side effects of extraordinary policy now seem to outweigh its ever-diminishing benefits. These side effects include:
- A greater likelihood of asset bubbles
- Increasing liabilities and balance sheet pressures for banks, insurance companies, and pension funds
- A greater tendency for individuals to save more to compensate for lower yields
- Less interest income for the sizable Baby Boom generation to spend
- The loss of competitiveness and efficiency as unnaturally low rates enable zombie companies to stay alive indefinitely
- A convenient excuse for other policymakers to shirk their responsibilities to implement structural reforms and provide fiscal stimulus
To be clear, no one is calling for aggressive tightening of monetary conditions, just a move away from DEFCON 1, the ultra-accommodative policies that have done little to bolster growth in recent years. It is also important to realize that not all central banks are facing the same trade-offs. Various countries and regions are at different points in the cycle, so each will have to decide how to weigh the knock-on effects. In the U.S., however, modestly stronger growth and inflation allow the Fed greater policy latitude than many other central banks. While the Federal Open Market Committee is unlikely to hike this week, the meeting provides an important opportunity to convey a more confidence-inspiring exit strategy.
Column by David Lafferty, CFA