Global central bankers are discovering that monetary policies they once viewed as unconventional and temporary are now proving to be conventional and long-lasting.
Forced to think outside the box by the 2008 financial crisis and then again this year by the coronavirus pandemic, the Federal Reserve, European Central Bank and most of their international counterparts have become more aggressive and innovative than ever in defending their economies from recession and the threat of deflation.
Recent months witnessed a return not just of policies first used on a widescale basis following the collapse of Lehman Brothers Holdings Inc., such as quantitative easing, but the adoption of even more esoteric ones.
The Fed is buying different types of bonds, the ECB is getting creative with negative interest rates, and Australia has adopted Japanese-style efforts to control bond yields.
With the global recovery still uncertain and the virus set to leave scars on employers and employees, the likelihood is that monetary policy will stay ultra-loose for years to come — even if that means central banks artificially propping up markets or sparking a run-up in prices.
Such an outlook was underscored by the Fed’s recent decision to say it will allow inflation to run above its 2% target in the future if needed to make up earlier undershoots. The Fed meets to set policy this week, as do the Bank of Japan and Bank of England, putting investors on alert for any signs of yet more innovation.
“The coronavirus crisis is many times more destructive than the financial crisis of 2008,” said Steve Barrow, head of foreign-exchange strategy at Standard Bank. “There’s every reason to believe that the move to tighter monetary policy will take as long –- and probably much longer — than the post-financial-crisis period.”
The mounting debate is whether the need to prop up economies will ultimately push central banks to do even more, perhaps in unison with governments. Monetary policy makers are already working closer than ever with their fiscal counterparts despite the traditional separation of responsibilities.
Potential steps include directly financing government budget deficits, a key tenet of Modern Monetary Theory which plays down the idea that there’s anything scary about monetizing debt. MMT, an old concept rebranded, is a prime example of formerly fringe notions gaining in prominence.
Policy makers are resisting such approaches for now, but they haven’t shied away from stretching their existing measures to extremes. Economists at Bank of America Global Research reckon that as of the end of July, central banks had cut interest rates 164 times in 147 days and committed $8.5 trillion in stimulus.
JPMorgan Chase & Co.’s measure of average global rates stands at just 1%, and that of developed nations is below zero for the first time.
The Fed, for example, responded to the pandemic with similar policies to those of 2008 but far faster — and then went even further. It slashed its benchmark to virtually zero and resumed buying government bonds, as well as widening its emergency lending authority to extend aid to municipalities, small- and medium-sized companies, and large corporations.
Its balance sheet is now at $7 trillion, compared to $4 trillion in January and the previous peak of $4.5 trillion in 2015.
The Fed has so far balked at cutting rates below zero, as the ECB and BOJ did years earlier, for fear of roiling the banking system or irking lawmakers. The ECB actually enhanced its own policy in March though, by introducing a super-low rate — even cheaper than its benchmark — for banks that use the cash to lend to the real economy.
The central banks of Australia, New Zealand and India are echoing Japan’s yield curve control with policies that deliberately trying to influence bond yields at specific maturities.
As for what assets central banks are willing to buy, there has been a sea-change well beyond U.S. shores. Australia, New Zealand and Canada bought government bonds for the first time this year with the latter also purchasing corporate debt. South Korea and Sweden began purchasing company bonds and commercial paper.
More central banks are also embracing so-called forward guidance, in which they commit to keeping their policy loose for a certain period to boost the confidence of investors, consumers and companies.
“As unconventional becomes the new conventional, central banks face fresh challenges,” said Tom Orlik, chief economist for Bloomberg Economics. “Extreme stimulus has worked well on the way in, exiting will prove harder to do — the first signs of rising inflation will be a test. Mission creep has pushed central banks into areas where coordination with fiscal policy and the need for democratic accountability raise questions about independence.”