Central Banks Weigh Different Policies Under Similar Constraints
The central banks of Japan, the U.K. and the U.S. will hold policy meetings this week. These three systemically important institutions are inclined to implement new policy measures, albeit different ones. Yet all three may end up keeping their policy stance as is. Their individual and collective dilemmas illustrate the current policy funk facing the global economy, as well as the urgent need for a macroeconomic policy pivot on three continents.
With the release this week of the quarterly inflation report, the Bank of England is likely to reiterate its concern about the potential impact of the uncertainty surrounding Brexit on growth, trade and investment prospects. In keeping with its previous signals, and given the government’s delay in spelling out a coherent strategy for exiting the European Union, the central bank would be inclined to put in place some additional policy “insurance” for the country’s well-being, including by cutting interest rates and, possibly, considering new balance sheet operations.
But the Bank of England also needs to acknowledge that the U.K.’s recent growth performance has been better than expected, even as inflation is increasing with the sharp depreciation of the pound. Together with growing -- and highly unfortunate -- political attacks on the central bank and its governor, particularly by members of the pro-Brexit camp, the rising risk of stagflation is likely to keep the bank on the policy sidelines for now.
The Bank of Japan faces another, similarly challenging policy dilemma.
After its surprising decision to venture deep into unconventional policy, including with negative policy rates, the Japanese central bank is committed to continuing to try to support growth and raise inflationary expectations. But its attempts to do so have been ineffective, if not counterproductive. And while the government continues to lag on the implementation of structural reforms -- the “third arrow” -- there is little to suggest that additional policy intervention would be any more successful this time.
The U.S. Federal Reserve faces the least challenging policy predicament when it comes just to economic and financial considerations, at least on paper. But that doesn’t take into account the bizarre politics of a highly unusual election.
U.S. third quarter gross domestic product growth came in last week at 2.9 percent, surpassing consensus expectations. Meanwhile, financial-market measures of inflation have been rising and labor market indicators have remained relatively solid. Along with what seems to be a wider recognition among a growing number of Fed officials of the rising risk of future financial instability, these factors would push the Federal Open Market Committee to be inclined to hike interest rates when it meets this week.
But the FOMC will be announcing its policy conclusions just a few days ahead of a very contentious presidential election characterized by many twists and turns that has featured questions about the political autonomy of the Federal Reserve, as well as its traditionally apolitical stance and the continued tenure of its chair, Janet Yellen. In this context, the likelihood of policy misinterpretation is significant, placing the Fed in a potential “lose-lose” situation. That means the FOMC is likely to choose the less visible and less risky policy path: delaying actions until after the elections..
The events of this week are likely to highlight again the extent to which good policy making on three continents is being undermined by “unusual uncertainty” caused by institutional and political factors. The outcome of the central bank meetings would show that these institutions, having been forced to carry too heavy a policy burden for too long, are now in an even more challenging phase.
And all three cases would reinforce the notion of the urgency of the policy pivot that I have described many times this year in columns and in my recent book, “The Only Game in Town.” The shift would involve moving away from prolonged and excessive reliance on central banks and in favor of a more comprehensive policy response that includes pro-growth structural reforms, more balanced demand management, lifting pockets of excessive indebtedness, improving global policy coordination and strengthening the regional economic architecture in Europe.
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Mohamed A. El-Erian at firstname.lastname@example.org
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Max Berley at email@example.com