The clueless company of central bankers
I had gone through the minutes of the meeting of the Federal Reserve Open Market Committee (FOMC) held in December, twice. It may be impolite to say but I think they are clueless.
The Federal Reserve threatened to taper in 2013. It began to reduce bond purchases in 2014 and concluded it by October of that year. In other words, from November 2014, it did not engage in quantitative easing. It made its first and only rate hike for 2015 in December. It made another rate hike in 2016 December. In 2017, it made three rate hikes.
In fact, at the beginning of 2015 and 2016, the Fed anticipated making three rate hikes each. That did not happen because economic growth was slower than they expected. After six years of zero rates and quantitative easing up to 2014, economic growth was still disappointing until 2016. Or, it could be that they were worried about China. I think both were factors.
So, monetary policy actions in 2007-08 might have avoided (we do not know for sure and we cannot) a bigger crisis but they certainly did not spark a sustained and sizeable economic recovery in the US. Therefore, it is difficult to say that the slightly faster economic growth in 2017 was due to monetary policy. It could have been due to other factors, such as the arrival of the new president and his deregulation agenda.
Nor has monetary policy stimulus helped create faster inflation in goods and services. Until now, inflation remains muted. If it accelerates in the coming months, it could be due to the recent increase in oil price. Again, the Fed will have failed in its inflation mandate too.
Perhaps, monetary policy can only be effective in reducing inflation (as Paul Volcker showed in 1979-82 and Alan Greenspan in 1994-95) and not in stoking inflation? If so, it is one more instance of the feature of asymmetry that is so much part of economic activity.
Take, for example, the impact of crude price on the real economy. It appears that sustained increase in crude prices usually preceded economic recessions or economic growth slowdown in the US and elsewhere. But, crude oil price declines did not help much at all (see “The Great Plunge in Oil Prices: Causes, Consequences, and Policy Responses, World Bank”). So, the oil price impact is asymmetric.
Even with financial markets, the Fed impact is asymmetric. When it raises interest rates, it does not seem to be able to tighten financial conditions. But, when it eases monetary policy, it is able to help ease financial conditions.
If central banks have no impact on real economic activity, have no impact on inflation (except to rein it in with hefty rate hikes that hurt growth) and if they can only help ease financial conditions (but cannot tighten them), do we really need a central bank?
Not so fast, you might say. Look at the European Central Bank (ECB). Their asset purchases have helped the European economy roar back to life from the Mediterranean to the Atlantic. The German Purchasing Managers’ Index (PMI) is at its highest since February 2011. Export orders are at their highest in 22 years. Spain PMI too was at its highest in November. So, is the ECB policy working better?
The ECB began purchasing assets in March 2015 at the rate of €60 billion per month. They increased it to €80 billion per month a year later. But, the German PMI did not bottom out until March 2016. The Spanish PMI did not bottom out until July 2016. Let us not forget that the ECB interest rates had come down to as low as 0.25% in November 2013. They have been at near zero since November 2014. The evidence is not persuasive that the monetary policy of ECB was any more effective than that of the Fed.
So, what caused the revival in the global economic activity? It is the escape of the Chinese economy from the doghouse that it found itself in, for much of 2015 and up to the first quarter of 2016. The escape was facilitated not so much by standard monetary policy action but through creation of money (credit) by banks. China revived its economy by creating a big real estate bubble. Old-fashioned sectors such as infrastructure and real estate were revived. Commodity prices found a floor. The world economy caught the spark and the dormant fires of monetary policy might have helped. May be, credit creation and monetary policy action are still effective in developing economies than in developed economies.
Frankly, this calls for introspection on the part of central banks in the advanced world. Their mandates and their models need drastic overhaul if not outright jettisoning. If they were honest and genuine intellectuals (one of the hallmarks of a true intellectual is openness to evidence), they would acknowledge that they retain the power to revive animal spirits in asset markets and blow bubbles but not much else.
If asset price bubbles across the world burst—as they inevitably will—central banks will have nowhere to hide. Not only will their policies be exposed as ineffective but they will also have precious little policy tools at their disposal to help revive economies. Not that these tools have helped, as the above analysis shows.
Recently released transcripts of the FOMC meetings held in 2012 show that Jerome Powell—the incoming chairman of the Fed—posed the right questions when the Fed embarked on the third round of quantitative easing. But, can he prevent the reputation of the institution he is going to head from being destroyed by the next market crash?
V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk
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