Cen­tral banks did what they could, but they’re not mir­a­cle work­ers

Bloomberg Businessweek (Asia) - - NEWS - By Michael Schu­man

No heart is im­mune from the up­lift­ing tale of the Lit­tle En­gine That Could—that plucky op­ti­mist who, against the odds, saved the day by chug­ging a stranded train over a moun­tain. In the world of eco­nomics, our cen­tral bankers have be­come this sto­ry­book over­achiever. Ever since the 2008 Wall Street melt­down, they have tried, tried, and tried again to pull the bro­ken global econ­omy into hap­pier times, un­daunted by set­backs, crit­i­cism, or the sheer weight of their bur­den. At times that un­stint­ing ef­fort has made them he­roes, too. The now-leg­endary 2012 pledge by Mario Draghi, pres­i­dent of the Euro­pean Cen­tral Bank, to do “what­ever it takes” to save the euro quelled the mar­ket tur­bu­lence that threat­ened to tear apart Europe’s mone­tary union.

To­day, though, cen­tral banks look more and more like the En­gines That Couldn’t. De­spite all their tire­less per­sis­tence, the world econ­omy re­mains stuck on the tracks, short of its ul­ti­mate des­ti­na­tion—a real re­cov­ery. The value of the of­ten highly un­ortho­dox meth­ods cen­tral banks have em­ployed along the route will be hotly con­tested by econ­o­mists for years, even decades. What’s be­yond ques­tion is that the in­sti­tu­tions just don’t pos­sess the horse­power to res­cue the global econ­omy.

That hasn’t stopped econ­o­mists and in­vestors from press­ing cen­tral banks to do even more. Draghi in early March dropped the ECB’s in­ter­est rates to record lows and ex­panded an un­con­ven­tional bond-buy­ing pro­gram—called quan­ti­ta­tive eas­ing, or QE—aimed at tamp­ing down rates even fur­ther. The Bank of Ja­pan is widely ex­pected to take more mea­sures to boost that slum­ber­ing econ­omy. In the U.S., the De­cem­ber de­ci­sion by Federal Re­serve Chair Janet Yellen to raise the bench­mark in­ter­est rate, af­ter seven years near zero, has been crit­i­cized by some an­a­lysts as a mis­take, and she’s re­cently sig­naled that in­ter­est rates would be raised more slowly than pre­vi­ously an­tic­i­pated.

The pleas for more cen­tral bank ac­tion seem to make per­fect sense. Mar­kets in the U.S. have been in tur­moil, and the econ­omy, though stronger than most oth­ers in the de­vel­oped world, is def­i­nitely not roar­ing. Europe and Ja­pan, strug­gling to grow and com­bat de­fla­tion, are in far worse shape. Un­der such cir­cum­stances, cen­tral banks usu­ally ease mone­tary pol­icy, mak­ing money cheaper to stim­u­late eco­nomic growth and prices. In the case of Ja­pan, Mar­cel Thieliant, se­nior Ja­pan econ­o­mist at re­search firm Cap­i­tal Eco­nomics, in­sists that “more eas­ing is surely needed.”

Yet the fact that the world’s ad­vanced economies are in such fee­ble con­di­tion ar­gues that eas­ier money won’t solve their prob­lems. Af­ter all, cen­tral banks have al­ready been gun­ning their en­gines at full throt­tle for seven years. In­ter­est rates re­main re­mark­ably low—in Ja­pan and the euro zone, they’re at zero. The ECB and BOJ have even re­sorted to neg­a­tive in­ter­est rates, ac­tu­ally charg­ing de­pos­i­tors for hold­ing cash, in an at­tempt to force banks to lend and busi­nesses to in­vest. And although the Fed wound down its sixyear QE pro­gram, the ECB and BOJ con­tinue to buy bonds on a mas­sive scale.

There’s no con­sen­sus on how much these cash-in­ject­ing ma­neu­vers have aided the real econ­omy—or helped at all. Sup­port­ers of Fed pol­icy, for in­stance, in­sist that its easy-money strat­egy suc­cess­fully shep­herded the U.S. through the Great Re­ces­sion and into a pe­riod of sta­ble growth with near full em­ploy­ment. At worst, they con­tend, the Fed pre­vented the econ­omy from tum­bling into an even deeper down­turn. De­trac­tors, how­ever, blame the Fed for caus­ing a litany of ills— ex­ac­er­bat­ing in­come in­equal­ity, en­cour­ag­ing a spendthrif­t gov­ern­ment, in­flat­ing a stock mar­ket bub­ble, roil­ing emerg­ing economies—while con­tribut­ing lit­tle to the Amer­i­can re­vival. Even Fed of­fi­cials don’t agree about the ef­fec­tive­ness of their own poli­cies. One 2015 study, by re­searchers at the Federal Re­serve Board, fig­ures that the Fed’s pro­gram made a sig­nif­i­cant con­tri­bu­tion to re­duc­ing job­less­ness, while another, penned by Stephen Wil­liamson, vice pres­i­dent at the Federal Re­serve Bank of St. Louis, as­serted that “there is no work, to my knowl­edge, that es­tab­lishes a link from QE to the ul­ti­mate goals of the Fed—in­fla­tion and real eco­nomic ac­tiv­ity.”

The lim­its of cen­tral banking are more ap­par­ent in Ja­pan. In 2013 newly in­stalled BOJ Gover­nor Haruhiko Kuroda em­barked on a gar­gan­tuan stim­u­lus pro­gram aimed at smash­ing en­demic de­fla­tion, en­cour­ag­ing bor­row­ing and spend­ing, and restart­ing growth in an econ­omy that’s stag­nated for more than two decades. But no mat­ter how quickly Kuroda has run his print­ing presses, the im­pact on Ja­pan’s out­look has been neg­li­gi­ble. The econ­omy tum­bled into re­ces­sion in 2014, and gross do­mes­tic prod­uct has con­tracted for two of the past three quar­ters. Prices, by one com­monly used mea­sure, didn’t change at all in Fe­bru­ary from a year ear­lier.

The ECB hasn’t fared much bet­ter. In early 2015, Draghi caught up with his peers and be­gan his own QE pro­gram to ward off a Ja­pan-style de­fla­tion­ary spi­ral. But prices in the euro zone re­ceded

0.2 per­cent in Fe­bru­ary. The zone’s GDP ex­panded an unin­spir­ing 1.6 per­cent in 2015, and the out­look for this year isn’t ex­pected to be any bet­ter, while un­em­ploy­ment is stub­bornly high at 10 per­cent.

Mean­while, there are in­di­ca­tions that cen­tral banks have al­ready gone too far. In Ja­pan, the BOJ’s poli­cies have so dis­torted prices that on March 1 the gov­ern­ment sold bench­mark 10-year bonds at a neg­a­tive yield for the first time. Yes, in­vestors made the oth­er­wise il­log­i­cal de­ci­sion to lend the gov­ern­ment their money and pay for the priv­i­lege of do­ing so. In turn, that al­le­vi­ates the ur­gency for the Ja­panese gov­ern­ment—the most in­debted in the de­vel­oped world—to rein in its bud­get deficits. Law­mak­ers and econ­o­mists fear that the use of neg­a­tive rates in Ja­pan and Europe will dam­age con­sumer sen­ti­ment and the health of banks. Even other cen­tral bankers are rais­ing con­cerns about their com­pa­tri­ots’ de­ci­sions. At a con­fer­ence in Shang­hai in Fe­bru­ary, Bank of Eng­land Gover­nor Mark Car­ney com­plained that neg­a­tive in­ter­est rates can weaken cur­ren­cies, help­ing coun­tries to ben­e­fit at the ex­pense of oth­ers.

In the des­per­ate quest to re­vive the global econ­omy, it seems we’ve all for­got­ten what we learned in col­lege eco­nomics. Mone­tary pol­icy is and al­ways will be an in­di­rect sci­ence. Cen­tral banks can pump money into an econ­omy, but un­less in­vestors, com­pa­nies, and con­sumers use it to build fac­to­ries, start en­ter­prises, or buy cars, the flood of cash won’t boost growth. In the end, it’s the de­mand for money that counts as much as the sup­ply.

That’s ex­actly what’s gone wrong in Ja­pan. De­fla­tion isn’t just a cause of the econ­omy’s paral­y­sis but also a symp­tom of deeper con­straints on growth. Ja­panese com­pa­nies are too bur­dened by high costs, wrapped up in red tape, and wed­ded to out­dated busi­ness prac­tices to take ad­van­tage of cheap cash. That shows print­ing money is no sub­sti­tute for real eco­nomic re­form. Prime Min­is­ter Shinzo Abe has leaned on Kuroda to solve eco­nomic prob­lems he’s been po­lit­i­cally un­will­ing to tackle. The re­form arm of his pol­icy plat­form, known as Abe­nomics, did make some progress, join­ing the Trans-Pa­cific Part­ner­ship free­trade agree­ment, for in­stance, and bol­ster­ing cor­po­rate governance rules. But it hasn’t se­ri­ously ad­dressed ma­jor flaws that ham­per growth and wel­fare, such as a dual-track la­bor mar­ket that con­demns too many work­ers to tem­po­rary jobs with lit­tle train­ing or op­por­tu­nity to ad­vance.

The same has hap­pened in Europe. Draghi’s ex­er­tions were never matched by the euro zone’s com­pla­cent po­lit­i­cal lead­ers. The aus­ter­ity-ob­sessed ap­proach to debt crisis, im­posed by Ger­man Chan­cel­lor An­gela Merkel, wasn’t off­set by growth-en­hanc­ing re­forms at the Euro­pean level, such as re­mov­ing re­main­ing bar­ri­ers within the com­mon mar­ket. In­di­vid­ual na­tions, from Ger­many to Greece, haven’t done enough to fix their own economies. In the U.S., Yellen could have ben­e­fited from a help­ing hand from Wash­ing­ton, but Congress has been too grid­locked by, among other things, the ide­o­log­i­cal stub­born­ness of the Tea Party wing of the GOP to take mea­sures that could boost the na­tion’s com­pet­i­tive­ness.

So to be fair to Yellen, Draghi, and Kuroda, we’ve ex­pected too much from them. Cen­tral bankers sim­ply can’t solve our eco­nomic prob­lems on their own, no mat­ter how hard they try. Ul­ti­mately, the poor post-crisis re­cov­ery was the fault of po­lit­i­cal lead­er­ship. Cen­tral banks had the power and will to step into the breach, and they hero­ically took up the bur­den. But it proved too heavy. Their en­gines have just run out of steam. <BW>

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