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| Economists, central bankers are rethinking the quantitative easing strategy that saved the world but created bubbles and distortions |
After an unprecedented monetary tightening campaign in recent decades, economists and central bankers are engaged in extensive discussions about the effectiveness of their past strategies and how to prevent future financial crises and cost-of-living challenges.
In a world marked by increased uncertainty, central bankers face the task of recalibrating their strategies amid growing concerns about rising interest rates, amplified by geopolitical tensions, including a new Middle East conflict. As we approach the end of a tumultuous year, three primary debates are at the forefront of these discussions: the flexibility of central banks in achieving inflation targets, the role of asset purchases in their policy toolkit, and the merits of aligning monetary and fiscal policies.
A global survey conducted by Bloomberg sought the opinions of economists from around the world on these critical debates. The consensus appears to be that central banks are unlikely to rush and jeopardize their economies in their pursuit of hitting inflation targets. Quantitative easing (QE) is expected to be used more cautiously in the future, and concerns are growing about potential conflicts between fiscal and monetary policies.
Bloomberg Economics suggests that the debate about aiming for a higher rate of inflation is gaining traction. However, central banks are likely to prioritize retaining credibility before making such changes, which may come after inflation returns to its target rate. As long as people believe that prices will stabilize around the 2% mark, central bankers will have some leeway in determining the aggressiveness of their actions in reaching that goal.
Economists covering the world's most influential central banks agree that policymakers are prepared to allow more time to bring inflation back to target if it means avoiding significant economic damage. A significant minority is even open to the idea of tolerating slightly stronger or weaker price pressures, as long as inflation expectations remain anchored.
Figures like Olivier Blanchard and Vitor Constancio have advocated for raising the inflation target, but this remains a contentious view and would likely require central banks to first restore inflation to 2%.
Global trends suggest that inflation will remain stronger than in the past, with former Bank of England Governor Mark Carney among those predicting that rates won't return to pre-pandemic lows. Gita Gopinath from the IMF argues that policymakers must be prepared to react preemptively to inflation episodes, even before they spiral out of control.
Concerns about the potential impact of supply shocks, like those from the Middle East conflict, may soon put central banks into action.
Conversely, when the next global economic slowdown occurs, flexibility may be necessary in the opposite direction. The eight-year experiment with negative interest rates in Europe ended with mixed reviews, leading to questions about its overall efficacy.
The Bank for International Settlements suggests that there may be more tolerance for moderate and persistent shortfalls in inflation because low-inflation regimes have self-stabilizing properties.
Rethinking Quantitative Easing
A more flexible approach to achieving the 2% inflation target would have led to a different post-2008 financial crisis monetary policy in many parts of the world. Trillions of dollars, euros, yen, and pounds were spent on asset purchases, yet they did little to raise prices against global disinflationary forces until governments injected cash directly into consumers' pockets during COVID-19 lockdowns.
This approach has been criticized for distorting financial markets, with episodes like the Silicon Valley Bank blow-up being linked to central bank reserves created under QE, alongside regulatory and supervision failures.
The survey reveals that only 40% of economists predict central banks will use QE as they did in the past. About a quarter expect it to be deployed more sparingly, while roughly 30% see its future role primarily addressing financial stability concerns, and a small minority believes it won't be used at all.
Another issue with bond-buying is that it can swap long-term borrowing costs for short-term ones, which, when official interest rates are low, benefits taxpayers but becomes a disastrous trade as rates rise.
In the UK, the BOE secured taxpayer indemnity for any losses on QE, estimating that its purchases will cost the government over £200 billion ($243 billion) over the next decade.
Furthermore, central banks have limited experience in unwinding their balance sheets, and small mistakes in this process can lead to significant market turbulence. The Federal Reserve's attempt to shrink bond holdings between 2017 and 2019 was met with challenges, though recent efforts have been smoother.
The ECB faces additional legal complexities with bond holdings due to its operation in a currency union of 20 countries, which has landed it in court several times over concerns about illegal financing and debt mutualization.
Mixing Policies
Low interest rates and large-scale QE programs enabled treasuries to finance stimulus campaigns, safeguarding labor markets, businesses, and consumers from collapse. However, the unprecedented spending during and after the pandemic has contributed to the recent surge in inflation.
Governments face the challenge of balancing economic stability with public sentiment. Tightening policies too aggressively may lead to voter backlash, potentially giving rise to populism or extremism. This dilemma raises questions about whether central banks can single-handedly achieve price stability.
Economists surveyed by Bloomberg anticipate that fiscal policy will somewhat counteract the Fed's efforts to control inflation in the US.
Some experts believe that a closer collaboration between fiscal and monetary policies is necessary for optimal economic management. However, central bank leaders like Jerome Powell remain cautious about relying on such cooperation, emphasizing their responsibility to deliver price stability, regardless of fiscal policy.
Central bankers emphasize that failure to scale back fiscal spending could result in higher interest rates. They call on elected officials to implement policies that support sustainable economic growth and reduce dependency on fiscal and monetary tools.
Agustin Carstens, the former governor of the Bank of Mexico and the current general manager of the BIS, suggests a change in mindset. He argues that growth should rely less on fiscal and monetary policy and more on structural policies.
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