Central bankers seek fresh policy tools to combat slowdown
The world’s monetary policymakers arrive in Jackson Hole, Wyoming, on Thursday for their annual summer gathering with two problems on their minds.
One they have known about for a while: despite dropping policy rates — in some cases below zero — central banks in developed economies still cannot meet their inflation targets.
The other problem is new: the uncertainty of open-ended trade negotiations is beginning to weigh on growth, even in America. Central bankers are becoming increasingly uncertain about their tools, but may have to use them soon anyway.
“I would say this is the probably the most interesting environment for central bankers since the crisis,” says Raghuram Rajan, a former governor of the Reserve Bank of India, now at the Chicago Booth School of Business.
The Kansas City Fed’s yearly conference on monetary policy has become a key moment for investors and politicians, who have in recent years come to expect major policy announcements.
Jay Powell, US Federal Reserve chairman, will in particular be closely watched when he speaks on Friday. Since the financial crisis, the chairman’s speech at the Jackson Lake Lodge has often been used to roll out new policies. That means investors will expect to hear something big from him — whether he has it or not.
In June, Mr Powell pointed out that the Fed’s policy rate, then at 2.5 per cent, was already close to zero, leaving little room to make a difference in the next downturn. This proximity was “the pre-eminent monetary policy challenge of our time”, he said.
The Fed is not alone. Since the financial crisis, central banks in other developed economies have dropped short-term interest rates; many are below zero. They have also purchased bonds in a bid to drag long-term interest rates down, a tactic that was once widely considered a heresy.
But after a decade of accommodative policies, central banks have failed to meet their inflation targets, and now they are left with low or negative policy rates.
“The question is, if you did two percentage points of easing, is that going to give you much oomph,” says James Stockman, a political economist at Harvard. “We don’t doubt that it’ll work . . . it’s just not going to be that potent.”
As a result, economists are on the hunt for alternative measures.
One group of highly respected former policymakers recently proposed that governments of developed economies should have clearly-defined fiscal spending projects ready for a downturn, paid for with debt bought by their central bank — a radical suggestion.
Jean Boivin, former deputy governor of the Bank of Canada and now head of research for the BlackRock Investment Institute, co-authored the paper with Stanley Fischer and Philipp Hildebrand.
“It’s difficult to envision stimulus in the next recession coming from pushing yields a lot lower than they already are,” he said.
Randall Kroszner, a former Fed governor, said central bankers were searching for a “shock and awe strategy . . . to make sure that markets realise they’re serious, and that they are going to have an impact”.
But the concern that market expectations cannot be changed would “haunt” attendees at Jackson Hole, he added.
What in June was an academic question about tools has become, in August, a policy question of when to use them. According to Fitch Ratings, more than a third of central banks have eased in the past six months, the most abrupt shift since 2009.
Growth has slowed in China and collapsed in Germany. In the US, protracted trade talks have started to wear on manufacturing. In the past week markets, expecting fresh stimulus, have lurched.
But Mr Powell’s dilemma is that the US data are not as bad as they are in Europe. Industrial production has slowed but it is not shrinking. Unemployment remains at levels not seen since the late 1960s, and American consumers continue to spend.
This leaves the Fed chairman without a clear mandate to ease policy.
As a result, Mr Rajan said he did not expect any big announcements. The Fed has been “fairly clear that there’s a lot of uncertainty on the efficacy of the tools”, he said. “It’s not clear to me that there’s a lot of additional enlightenment we can get at this point.”
In its most recent survey of consumers the University of Michigan asked about the Fed’s July rate cut, which Mr Powell explained as “insurance” against trade risks. Consumers answered that a cut was a sign of a recession. Perversely, bond price movements showed that investors did not believe the Fed had committed to easing policy.
Ellen Zentner, chief US economist for Morgan Stanley, said the Fed may pay a price for its open conversations about policy options.
“The market sees the Fed showing them their hand, showing them how the sausage is made,” she said. “You run the risk of showing the market there is very little you can do.”
Mr Powell is looking at ambiguous signals. Investors think he is unclear. And the president of the United States frequently accuses him of being slow to act.
As policymakers gather in Wyoming, he will be expected to say something that will satisfy all these constituencies — and his biggest problem may be that he has been too honest about the Fed’s limitations.