Politicians are ready to take the baton
Stock markets and other asset classes will have some adjusting to do
Article 50 by Prime Minister Theresa May’s government in the UK. The market regime transition would be accelerated, however, if the central bank took this opportunity to change its forward guidance — away from signalling continued loose and, effectively, open-ended balance sheet support to suggestions of a gradual taper over time.
When it comes to effectiveness, markets have yet to internalise the multiple dimensions associated with the simple fact that this is a different type of “put”.
Inclusive growth
On the positive side of the ledger, for example, transitioning from over-reliance on central banks to a broader policy response has the potential to generate higher and more inclusive growth, as well as strengthen the underpinnings of genuine financial stability. Both of these would help validate existing asset prices and even push them higher over time in a sustainable fashion.
On the negative side, however, the new policy construct is less autonomous when it comes to implementation. Unlike the Fed, which can pursue measures without congressional approval (though that offers a significantly narrower policy set), the president needs congressional approval for a lot of what he has suggested for promoting growth. And such approval is subject to influences that go beyond the merit of the measures themselves.
As an illustration, there is some concern that the administration’s taking on health care ahead of tax reform means the implementation of an important item of the progrowth agenda could be delayed by political divisions over the effort to repeal and replace Obamacare.
The “central bank put” was extremely supportive of asset prices for several years. For the “presidential put” to be similarly beneficial, good policymaking by the Trump administration would not prove sufficient unless it is accompanied by sound economic governance by Congress.