The Fed must be ready for trouble not normality
A week after the European Central Bank launched a major new round of monetary stimulus, the Federal Reserve, too, enacted another cut in interest rates. It was right to do so. The normalisation of monetary policy seems more distant than a few months ago. The sooner central bankers reconcile themselves to this, the better. Any doubts that the global economy is worsening should be dispelled by the OECD’s updated Economic Outlook, published on Thursday. The multilateral think-tank sharply downgraded its growth projections. It now thinks the global economy will grow by 2.9 per cent this year, 3 per cent next year, down -0.3 and -0.4 since its previous forecasts which were issued as late as May. Virtually no countries escape this deterioration. While the US can still expect stronger growth than most rich economies, its prospects are worsening just as fast as the global average.The reason is plain, and in the US’s case, self-inflicted. The effects of President Donald Trump’s trade war can be seen in one worrying indicator after another. Global trade volumes are shrinking and uncertainty over the future of trade intensifying. The result is a manufacturing and investment drought: capital goods production has stalled; global car sales are contracting fast. While the US is less exposed to external troubles than smaller or more open economies, it cannot shield itself completely from the fallout. US industry is now in recession.And yet Federal Reserve chair Jay Powell faces hardening opposition to looser policy, much like his opposite number, the ECB’s Mario Draghi. The split on the Federal Open Market Committee, where two members voted against the rate cut, is perhaps not shocking when the economic tea leaves are harder to read than in more normal times. It is also true that monetary policy cannot do anything about the core problem of the trade war, which is a disruption of supply chains and a threat to the economy’s productive capacity.But trade uncertainty hurts demand, too, especially investment demand. The demand-side damage can precede the supply-side adjustment the trade war may require, and may bring long-term losses of productivity. The Fed, like other central banks, should do what it can to keep demand expectations and the desire to invest buoyant.Where Mr Draghi has chosen to give the dovish majority an unequivocal voice, however, Mr Powell has been less willing to pick one side and defend it strongly. That clouds the expectations of markets, businesses and consumers. It also blunts the effectiveness of the loosening. Pre-emptively ruling out radical measures such as negative interest rates, as Mr Powell came close to doing, does not help.The unexpected funding squeezes in the repo market this week risk adding to a perception that the Fed is not fully in control. Whatever the cause, it was a problem the Fed can and did easily address by lending reserves against collateral. That is, after all, a classic example of what central banks do. The fact that the repo rate briefly shot up, however, indicates that the Fed should upgrade its facilities to make central banks’ cash more readily available whenever needed.That is not to say it should embark on a new balance sheet expansion through quantitative easing. This is a matter of monetary policy, not financial market plumbing. But it does suggest that even the large amount of excess reserves created through past easing does not guarantee liquidity in key markets.The Fed must stand ready to address both economic slowdown and market dysfunction. It should aim not for normalisation but its opposite.