Central Bankers Discover Their Limits After a Tough Yearby , , and
Governments are expected to increase spending throughout 2017
Monetary stimulus may have peaked, tapering is now more likely
It was the year central bankers discovered their limits.
Instead of earning praise for shouldering the burden of sluggish global growth, monetary policy makers this year were scolded for meddling. Negative interest rates were blamed for crimping bank earnings. Massive bond buying programs were singled out for stoking market speculation rather than investment.
Now, amid surging populism and as government spending comes back into vogue, 2017 is shaping up to be the year that central bankers quietly shuffle from center stage.
The Bank of Japan has already realized its tools can only do so much. The European Central Bank has signaled its bond purchases aren’t infinite. At the Federal Reserve, Chair Janet Yellen discovered how very low interest rates had little effect on the supply side of the economy.
“Central banks ran out of gas this year,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. “Monetary accommodation may thus have peaked this year and may be gradually dialed back.”
Critics of central bank actions were emboldened by a still sluggish global economy even after years of unprecedented monetary stimulus.
In the U.S., President-elect Donald Trump has called for an audit of the Fed. Yellen and her colleagues this week lifted borrowing costs for only the second time in a decade and after projecting four hikes for 2016. The central bank’s policy panel now expects three rate rises in 2017, yet Yellen also said the outlook is “highly uncertain.” She warned that the so-called neutral interest rate, that keeps “the economy operating on an even keel,” remains “quite low” by historical standards. For all its monetary stimulus, the Fed hasn’t hit its 2 percent target in more than four years and doesn’t expect to get there until 2018.
South Korean lawmakers were unusually vocal in warning of the risks associated with record low borrowing costs. Japanese politicians repeatedly dragged their central bank chief into parliament for questioning as some warned that BOJ policies were confusing.
William Hague, the former U.K. foreign secretary and Conservative Party leader, said in October that central banks’ failure to reverse ultra-loose policy could cost them their independence. After an era of ultra-expansive monetary policy in most of the developed world, threats to their right to act unchallenged could multiply in a period of populist politics.
“What we learned is that a central bank can make extra aggregate demand, but they can’t make any extra aggregate supply," said Vincent Reinhart, chief economist at Standish Mellon Asset Management in Boston. “In an environment where populations are aging and productivity performance is poor, they have to live within those means.”
In the case of Japan, Haruhiko Kuroda’s embrace of negative rates shocked investors and did little to nudge inflation closer to the BOJ’s 2 percent target. As the economy continued to struggle, the BOJ was forced to review its strategy and signal its bond buying couldn’t go on forever as policy switched focus to targeting yield curves from printing money.
The People’s Bank of China didn’t get much love for its role in stabilizing the economy and markets after a deluge of criticism from around the world that the bank wasn’t communicating clearly enough. By year end, the PBOC too had changed course from pumping up demand to focusing on reigning in a growing credit bubble.
For Mario Draghi, 2016 was a lot about learning how to keep going despite the obvious practical and political limits to the ECB’s powers. He expanded the quantitative easing program to 80 billion euros ($83 billion) per month in defense of the bank’s inflation mandate, while using every chance to tell the region’s politicians that they need to do more to boost growth.
And having faced difficulties in finding enough available assets to buy and stiff political opposition from Germany and elsewhere, the ECB’s year in stimulus was a hard slog. And as turn of the year neared, Draghi managed to dial the program back while actually extending it -- adjusting to 60 billion euros a month until December 2017. What remains is a very clear reminder that it won’t be there to underpin euro-area growth forever.
“I think they are losing heart in what they are doing,” said Gilles Moec, chief European economist at Bank of America Merrill Lynch in London. “The bar for them to go back to 80 is very high.”
Bank of England Governor Mark Carney also found himself in the trenches, arguably deeper than his ECB counterpart. As the U.K. stumbles toward starting the legal process to leave the European Union, Carney may seek to avoid the limelight and the accusation he faced this year that he’s politically motivated.
Carney and his monetary policy committee were first accused by pro-Brexit politicians of scare-mongering in the run-up to the vote, then for overstating the potential economic damage when the expected effects of a vote to leave didn’t all materialize.
Prime Minister Theresa May fretted over the “bad side effects” of loose monetary policy. She and other Conservative lawmakers have said low rates and quantitative easing disproportionately benefit asset-holders, undermine savers, weaken banks and widen pension deficits.
On Thursday, the BOE kept its key interest rate at a record low, and remarked that the pound’s recent appreciation could help keep a lid on inflation.
“One thing they may have learned is that they’re not beyond the gaze of politicians,” said Azad Zangana, an economist at Schroders Investment Management in London. “Whilst they had argued that Brexit would be negative for the economy, now that it’s becoming a reality, they’re not trying to influence the decisions going forward.”
On a gloomier note the same day, the Swiss National Bank said that a “multitude of political uncertainties” could challenge its efforts to prevent the franc from strengthening.
To be sure, not all of the criticism is valid. Central banks have played a role in heading off a global deflation scare as prices gradually increase. Economic growth is improving as years of stimulus start to gain traction in the world’s largest economies. In explaining the decision to hike rates, Yellen cited strength in the U.S. economy.
The shift to governments has already started. Japan is yet again rolling out fiscal stimulus and Trump has pledged to shepherd as much as $1 trillion of spending on new roads and bridges to juice up demand. Others, such as Canada and South Korea, are joining in. China’s economic stabilization has relied on fiscal stimulus and even in Europe there are signs resistance to additional government spending may be softening.
But to really lift growth, elected leaders are going to have to dig deep and roll out unpopular reforms. That means less central bank action, more political will.
“We are in the early stage of a great rotation towards more reliance on government policy and less on central banks,” said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors. "The ECB and BOJ will be on autopilot for much if not all of the year and the Fed will still be a focus as to how much it raises rates."