The Fed Meets Expectations, With a Caveat
As was widely anticipated, Federal Reserve officials refrained from adopting new policy measures at the conclusion of their two-day policy meeting on Wednesday. But they went somewhat beyond the rather bland statement that most market participants had expected.
Because more positive domestic economic developments, including a “strengthened” labor market after the dip in May, continue to face headwinds from a weaker international context, the Fed saw no immediate need to hike interest rates. More notably, officials observed that "near-term risks to the economic outlook have diminished," a statement that was somewhat stronger than consensus expectations. Interestingly, however, this comment has not led -- at least yet -- to higher short-term market interest rates as I had suggested might happen.
What is less clear from the statement -- though it may become more evident when the minutes of the meetings are released in a few weeks -- is the range of specific factors that Fed officials are taking into account in making tough judgment calls involving several complex trade-offs: between relative domestic economic strength and international weakness; between repressing short-term financial volatility and the risk of greater financial instability down the road; and between cautious restraint on rates and hiking now to create room for future policy responses if domestic economic activity hit a pothole.
When it comes to these complicated trade-offs, I suspect that Fed officials will also keep a close eye on other systemically important central banks. None of these faces a greater policy challenge than the Bank of Japan, whose policy-making two-day meeting starts Thursday amid heightened expectations of additional stimulus.
On two previous occasions this year, the Bank of Japan saw markets react in unexpected and perverse ways to its policy announcements, including by pushing the currency significantly higher when the central bank unexpectedly took nominal rates below zero. This time, BOJ officials may feel slightly better about their policy prospects now that the government has reinforced its parliamentary majority and Prime Minister Shinzo Abe feels more emboldened to press forward with fiscal stimulus and structural reforms.
Whether at the Fed, the Bank of Japan or a number of other central banks, the key issue remains the same.
Almost eight years after the height of the global financial crisis, the world is still far too reliant on central banks to promote high inclusive growth and ensure genuine financial stability. The longer this persists, the less likely that the desired outcomes will materialize. Meanwhile, the risks to the central banks’ policy credibility will grow, as will the threats to their political autonomy; and the scope for collateral damage and unintended consequences will be consequential.
It has long been time for governments to a pivot away from excessive dependence on central banks and toward a policy response that combines more comprehensive demand management with pro-growth structural reforms, the lifting of pockets of excessive indebtedness, and better regional/global policy coordination. The longer this policy handoff is delayed, the greater the risk that other central banks may follow the BOJ in seeing their policies a lot less effective, if not ineffective and even counter-productive.
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Mohamed A. El-Erian at firstname.lastname@example.org
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