The Levelling by Michael O'sullivan

Author:Michael O'sullivan
Language: eng
Format: epub
Publisher: PublicAffairs
Published: 2019-05-28T00:00:00+00:00

The Future of Central Banking

In 2018, the Federal Reserve began to step slowly, carefully back from quantitative easing programs, and other major central banks hinted at an era of policy normalization. The next recession or financial crisis will test their mettle. Have they simply throttled back extraordinary monetary policy, ready to rev it up again, or are they willing to step back in principle from the positions of overwhelming power they find themselves in?

There are three avenues down which central bankers can travel. The first is more of the same: to continue to use central bank balance sheets to curb markets and to try to stimulate growth. Under this option there will be plenty of talk of “adding to the toolbox,” that is, inventing new measures to try to coax growth out of sluggish economies.21 The results may simply be more market distortion, a dwindling sense of urgency among politicians as to their task lists, and an undermining of the credibility of central banks as independent public institutions.

If anything, recent pronouncements from central bankers suggest that, in the case of a recession, the consensus view among monetary economists supports more aggressive bouts of monetary stimulus rather than the disengagement of central banks in favor of fiscal-policy-led solutions to low growth.22 Public discussions by central bankers in the United States and Europe, for example, point toward a mind-set that is now set on zero and negative rates as the default policy stance of major central banks. My worry is that these seemingly aggressive policies will prove ineffective in the face of a serious economic shock, such as a full recession in China, which would sharply curb economic demand globally.

The second avenue is for central bankers to step back and let politicians use fiscal policy more actively. The rationale here is that active fiscal policy in the context of cheap money would stir the embers of the world economy. In certain cases this might work, but it comes too late. Fiscal policy like infrastructure programs tends to work with a lag. For this reason it is often best deployed at the bottom of a recession because it cushions the blow of a downturn and helps provide the basis for a recovery, particularly if money is wisely spent. At the time of this writing, some large economies—the United States and China—are heading toward their next natural, or likely, recession. In this case, their fiscal powder is best kept dry for a couple of years rather than being ignited unproductively now. The other side of fiscal policy, structural reform (such as making labor markets more dynamic), is something for which most politicians have little appetite.

A third option is to stop the range of extraordinary measures being deployed by central banks altogether. A very bold framing of this would be an agreement or world treaty on risk, crafted along the lines of large-scale environmental or nuclear weapons deals. Under such an agreement, the world’s major central banks would agree to use extraordinary measures like QE only under preset conditions (great market and economic stresses).

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