If Central Banks Are the Only Game in Town, We’ve Lost
Relying on monetary policy to prop up asset prices and smooth out global volatility is a recipe for disaster.
Just since December 2018, central banks have collectively injected as much as $500 billion of liquidity to stabilize economic conditions. The U.S. Federal Reserve has put interest rate increases on hold and is contemplating a halt to its balance-sheet reduction plan. Other central banks have taken similar actions, fueling a new phase of the “everything bubble” as markets careen from December’s indiscriminate selling to January’s indiscriminate buying.
The monetary onslaught appears a reaction to financial factors — falling equity markets, rising credit spreads, increased volatility — and a perceived weakening of economic activity, primarily in Europe and China. If they heeded Walter Bagehot’s oft-cited rule, central banks would act only as lenders of last resort in times of financial crisis, lending without limit to solvent firms against good collateral at high rates. Instead, they’ve become lenders of first resort, expected to step in at any sign of problems. U.S. central bankers are currently debating whether quantitative-easing programs should be used purely in emergency situations or more routinely.
Since 2008, the global economy has grown far too dependent on huge central bank balance sheets and accommodative monetary policy. The U.S. economic boom President Donald Trump loves to tout is largely fake, engineered by artificial policy settings. Such dependence is dangerous and, for various reasons, could well backfire.
For one thing, central banks are poor forecasters. GDP growth, inflation and labor markets may prove more resilient than feared, remaining at or above trend. Key risks, such as the trade dispute between the U.S. and China, may recede. Financial markets and asset prices have already recovered substantially.
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