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14 Feb 2013
The Age of easing and the new direction of Central banks
As the world’s developed economies experience tepid growth at nearly half the rate of the pre-crisis years, the specter of persistently high unemployment and long-term ramifications has several governments resorting to a new set of monetary-policy makers bent on saving their respective countries from financial oblivion.
The genesis of this movement has its roots back in November 2011 with President Mario Draghi at the European Central Bank now, however several other key players have emerged since then. With a fresh perspective of leadership in the Bank of England and the Bank of Japan, along with the prospect – however unlikely – of Federal Reserve Chairman Ben Bernanke being slated for replacement, investors are left to wonder what the new direction of central banking will be in the foreseeable future as murmurs of ‘currency wars’ envelop the financial world.
This gradual changing of the guard reflects both an acute need for central banks to offset fiscal debilitations and a bid that monetary policy remains a potent and necessary force moving forward. Simultaneously, investors are increasingly weighing the costs and benefits of quantitative easing, which has drawn the ire of many around the world amidst a sea of controversy. Moreover, the recent appointments of activists “reflect the case that economies are still struggling to sustain solid recoveries and there’s pressure from political quarters to be more simulative,” wrote Nathan Sheets, a former adviser to Bernanke and now global head of international economics at Citigroup Inc. “Central banks have stuff in the bag, but it’s largely untried and may generate unwelcome side effects.”
Indeed, Quantitative easing has yielded an impact no doubt – it is simply a question of prolonged success and cost. Research by economists at the Fed last year estimated the initial two rounds of asset purchases reduced unemployment by 1.5% and staved off the threat of deflation – once thought unthinkable in the US. Additionally, the Bank of England estimated in July that nearly £200 billion ($311 billion) of bond buying between March 2009 and January 2010 raised gross domestic product by as much as 2% and inflation by 1.5%.
Bernanke’s own research as a Princeton University professor criticized Japanese policy makers in the 1990s for a reluctance “to try anything that isn’t absolutely guaranteed to work,” he stated in a January 2000 paper. The lesson is to keep pumping and be more innovative if needed, added Danny Gabay, a director of Fathom Consulting in London. He calculates that fiscal policy, the other main mechanism of economic management, was eased 15 times in Japan since 1997, to little avail.
“What we have now is a monetary problem, so it’s time for a monetary solution,” said Gabay, a former Bank of England official. “It’s tough to make monetary policy effective, but it’s the only way.” The bid for governments of appointing activists is that they have run out of room, tools, and leverage to ease fiscal policy and would quite simply prefer that central banks go for growth, even at the expense of a climb in prices Indeed, central bankers in some countries already are indicating a willingness to tolerate above-target inflation despite their mandates.
The International Monetary Fund (IMF) last month cut its forecast for expansion in developed economies this year to +1.4%, down from an October estimate of +1.5%, which is nearly half the average rate of the golden growth years from1994 to 2003. The Washington-based lender also predicts the average inflation rate in these nations will remain less than 2 % through 2017 and unemployment could top 8% this year. Finally, it projects the average budget deficit at 4.9% of GDP.
The genesis of this movement has its roots back in November 2011 with President Mario Draghi at the European Central Bank now, however several other key players have emerged since then. With a fresh perspective of leadership in the Bank of England and the Bank of Japan, along with the prospect – however unlikely – of Federal Reserve Chairman Ben Bernanke being slated for replacement, investors are left to wonder what the new direction of central banking will be in the foreseeable future as murmurs of ‘currency wars’ envelop the financial world.
This gradual changing of the guard reflects both an acute need for central banks to offset fiscal debilitations and a bid that monetary policy remains a potent and necessary force moving forward. Simultaneously, investors are increasingly weighing the costs and benefits of quantitative easing, which has drawn the ire of many around the world amidst a sea of controversy. Moreover, the recent appointments of activists “reflect the case that economies are still struggling to sustain solid recoveries and there’s pressure from political quarters to be more simulative,” wrote Nathan Sheets, a former adviser to Bernanke and now global head of international economics at Citigroup Inc. “Central banks have stuff in the bag, but it’s largely untried and may generate unwelcome side effects.”
Indeed, Quantitative easing has yielded an impact no doubt – it is simply a question of prolonged success and cost. Research by economists at the Fed last year estimated the initial two rounds of asset purchases reduced unemployment by 1.5% and staved off the threat of deflation – once thought unthinkable in the US. Additionally, the Bank of England estimated in July that nearly £200 billion ($311 billion) of bond buying between March 2009 and January 2010 raised gross domestic product by as much as 2% and inflation by 1.5%.
Bernanke’s own research as a Princeton University professor criticized Japanese policy makers in the 1990s for a reluctance “to try anything that isn’t absolutely guaranteed to work,” he stated in a January 2000 paper. The lesson is to keep pumping and be more innovative if needed, added Danny Gabay, a director of Fathom Consulting in London. He calculates that fiscal policy, the other main mechanism of economic management, was eased 15 times in Japan since 1997, to little avail.
“What we have now is a monetary problem, so it’s time for a monetary solution,” said Gabay, a former Bank of England official. “It’s tough to make monetary policy effective, but it’s the only way.” The bid for governments of appointing activists is that they have run out of room, tools, and leverage to ease fiscal policy and would quite simply prefer that central banks go for growth, even at the expense of a climb in prices Indeed, central bankers in some countries already are indicating a willingness to tolerate above-target inflation despite their mandates.
The International Monetary Fund (IMF) last month cut its forecast for expansion in developed economies this year to +1.4%, down from an October estimate of +1.5%, which is nearly half the average rate of the golden growth years from1994 to 2003. The Washington-based lender also predicts the average inflation rate in these nations will remain less than 2 % through 2017 and unemployment could top 8% this year. Finally, it projects the average budget deficit at 4.9% of GDP.