Macro Commentary
What else have they got? That is the question that continues to come up in our discussions with investors as we have talked about the chink in the armor of central banks’ after the recent Japan experience. At the end of January, the Bank of Japan (BoJ) surprised markets with a move into negative interest rates – a policy experiment that had been underway in Europe. Using the past few years as a playbook, a surprise easing by a central bank would result in currency weakening and risk assets (such as equities) gaining. Looking back now one month, the exact opposite has happened. The yen is about 6% stronger than it was just before the announcement. The Nikkei 225 (a broad Japanese stock index) fell more than 14% from the January month-end level before bouncing back a bit to be down more than 7% in February. It is no wonder that journalists and investors wonder if central banks are out of bullets.
Naturally, this is also a topic of conversation as policy makers from the 20 largest economies gather in Shanghai to discuss the state of the global economy. Just yesterday, the Bank of England (BoE) Governor Mark Carney commented that central banks are not out of “monetary ammunition” but “that our firepower must be well aimed.” While some of this is likely posturing (the old adage never let them know you are out of bullets), our experience post-financial crisis has shown that central bankers are willing to be creative in putting a little “extra” into their extraordinary policies. It is natural that there are diminishing marginal returns to early tools like forward guidance (i.e. talking about future policy) and quantitative easing. Over time, policies have to be bigger and bolder to have the same effect.
So the question is, what else can central banks do? The answer of what else can be done is a frustrating one – it depends. It depends on what central bank you are thinking about and their current circumstances. Negative interest rates could go lower, but not all central bankers are in favor of negative interest rates. Carney is not. Some central banks like the Fed and the BoE have positive interest rates they could let fall back towards zero. Some central bank balance sheets could also take more QE and follow the Japanese example of buying assets other than government bonds (Japan has even bought equities and REITs). Central banks could use QE to monetize fiscal spending on government projects. Of course, this requires a legal framework that allows it (a challenge in the Eurozone) and coordination/action by politicians (difficult anywhere). They could use language to adjust their target inflation rate or the timeline to achieve. This is just a short list and I am sure there are ideas that go beyond this. So, the real question is not what more can central banks do because there is plenty. Instead, the real question when can there be enough economic strength and confidence for them to do less?