Central bankers take risks on recovery
Banks embarking on never-before tried policies to keep credit flowing
As global central banks race to rescue their economies from coronavirus devastation, they are crossing red lines and trying out policies they had never before attempted. They’re probably not done yet.
Faced with a crisis unlike any other in memory, central bankers have embarked on new efforts to keep credit flowing and to set the stage for an economic turnaround. Because they went into the crisis with limited ammunition to stoke growth, experimentation may prove even more crucial in the months and years ahead as the world embarks on what could be a long slog back to prosperity.
In the United States, the Federal Reserve is buying municipal debt and corporate bonds and lending to mid-size companies — embracing never-before-tried efforts to keep credit markets functioning. The European Central Bank is accepting recently downgraded junk bonds as collateral in return for cheap loans, and the Reserve Bank of Australia is buying government bonds to keep the rate on three-year debt steady at a quarter of a percentage point.
Those attempts, along with others elsewhere, go beyond what monetary authorities did even in the darkest days of the 2008 global financial crisis.
The Fed “crossed a lot of red lines that had not been crossed before,” Jerome Powell, its chair, said during a recent online appearance. Despite the risk, he added, “this is that situation in which you do that, and you figure it out afterward.”
Policymakers are going to new lengths in part because there had never been an economic shock like the one caused by the pandemic, in which the world closed up shop simultaneously. The U.S. economy officially tipped into recession in February, the National Bureau of Economic Research declared on Monday.
Central bankers entered the crisis with low interest rates, leaving them less room to goose growth using their tried-andtrue tools.
Their efforts joined a wave of fiscal policy — moves by elected governments with taxing and spending powers. The United States, Germany, France and many other countries have poured trillions of dollars into their economies through tax cuts, cheap credit and cash handouts. Monetary policy and fiscal policy can act as complements during a crisis to restore economies.
But appetite for further fiscal action is eroding in some places, including the United States. And the next stage — the recovery — could pose a fresh test for the world’s central banks, forcing them to get more creative as they try to keep pandemic aftershocks from permanently scarring growth potential and to avert economy-damaging price declines. The Fed and its global counterparts are shifting from crisis-fighting mode, when they worked to keep credit markets open, to a period when they must stoke lending and spending to get economies churning again.
Central banks have historically cut interest rates to lift the economy during and after shocks, but borrowing was so cheap going into this downturn that they need to turn to unconventional approaches. Some are already experimenting with new ideas to stimulate demand — the Bank of Japan has intensified its efforts to stabilize markets through stock fund purchases, and the European Central Bank has a pandemic-related bond-buying plan in place — while others are likely to get creative soon.
“It will be a potential concern as the economy turns around, if that turnaround is less than ideal,” said Donald Kohn, a former Fed vice chairman now at the Brookings Institution. “Central banks will have to work hard at supplying the extra push, the extra zip that they’d want to achieve.”
At its meeting on Thursday, the European Central Bank said it would nearly double a de facto money printing program to 1.35 trillion euros, or $2 trillion (Canadian), to ensure a steady flow of cheap credit to eurozone consumers and businesses. The bank was already allowing commercial banks to borrow money at a negative interest rate of one per cent if they lend the funds to customers. In effect, the central bank is paying commercial banks to hand out loans. The Fed, which meets in Washington this week, is expected to use so-called forward guidance — a pledge to leave interest rates near rock bottom for an extended time — to manage investors’ rate expectations and stimulate the economy.
Some analysts warn there is a danger that central banks and elected officials will overshoot in their rush to prop up their economies. According to that logic, they are flooding the world with cash at the same time that restaurants, airlines and retailers are being driven out of business.
That will create an imbalance between demand and supply that will lead to higher prices, argues Oliver Harvey, a macroeconomic strategist at Deutsche Bank.
“The government is handing out $100 bills when there is nowhere open to spend them,” Harvey wrote in a recent article. Food prices were already rising sharply in Britain, he said, attributing it to “more money chasing after significantly fewer goods and services.”