Can central bankers succeed in getting global economy back on track?

By Anatole Kaletsky
August 15, 2014

Stanley Fischer, the former chief of the Bank of Israel, testifies before the Senate Banking Committee confirmation hearing on his nomination in Washington

Why is the world economy still so weak and can anything more be done to accelerate growth? Six years after the near-collapse of the global financial system and more than five years into one of the strongest bull markets in history, the answer still baffles policymakers, investors and business leaders.

This week brought another slew of disappointing figures from Europe and Japan, the weakest links in the world economy since the collapse of Lehman Brothers, despite the fact that the financial crisis originated in the United States. But even in the United States, Britain and China, where growth appeared to be accelerating before the summer, the latest statistics — disappointing retail sales in the United States, the weakest wage figures on record in Britain and the biggest decline in credit in China since 2009 — suggested that the recovery may be running out of steam.

As Stanley Fischer, the new vice chairman of the Federal Reserve Board, lamented on August 11 in his first major policy speech: “Year after year, we have had to explain from mid-year onwards why the global growth rate has been lower than predicted as little as two quarters back. … This pattern of disappointment and downward revision sets up the first, and the basic, challenge on the list of issues policymakers face in moving ahead: restoring growth, if that is possible.”

The central message of Fischer’s speech — that central bankers and governments should try even harder than they have in the past five years to support economic growth — was closely echoed by Mark Carney, the governor of the Bank of England, at his quarterly press conference two days later.

Bank of England Governor Mark Carney attends the bank's quarterly inflation report news conference at the Bank of England in LondonThis consistency should not be surprising: Carney was Fischer’s student at the Massachusetts Institute of Technology in the 1970s — as, even more significant, was Mario Draghi, president of the European Central Bank. Because of Fischer’s influence on other central bankers, as well as his unparalleled combination of academic and official experience, he is probably now the world’s most influential economist.

When President Barack Obama appointed him vice chairman of the Federal Reserve, Fischer was widely viewed as more hawkish than Chairwoman Janet Yellen. He was considered a restraining influence on her instinct to focus on jobs and growth rather than inflation control.

So investors and business leaders should pay attention when Fischer makes his first major speech a call for more explicitly growth-oriented monetary policies — a call that other central bankers are already heeding.

Carney made this clear when he surprised financial markets by revealing no hint of anxiety about inflation or financial bubbles. He instead reiterated the Bank of England’s interest rate policy of “lower for longer” than almost anyone expects. To the chagrin of currency traders, who had been buying sterling on the assumption that Britain would be the first major economy to raise interest rates — perhaps as early as this year.

Even at the European Central Bank, the once taboo idea that monetary policy can be used to stimulate growth is suddenly open for discussion — if not yet conventional wisdom.

ECB President Draghi addresses a news conference in BrusselsDraghi, in his recent policy statements, has unequivocally promised that the European Central Bank would keep interest rates at zero far longer than the Fed and has openly welcomed the weaker euro this policy should produce. There has also been no criticism for this ultra-dovish policy from German Chancellor Angela Merkel or the Bundesbank — if only because the German economy is reeling from the body-blow of the sanctions war with Russia and the violence in Ukraine.

But what of Fischer’s discouraging caveat at the end of his quote? The challenge, he said, “is restoring growth, if that is possible.”

Many economists now say there is nothing more that policy can do to stimulate growth or employment,  a view shared by many industrialists, financiers and politicians. Fischer is clearly not among these skeptics, and neither are the other leading central bankers.

Though official statements from leading policymakers are invariably hedged with qualifications, the gist of Fischer’s speech is clear: Restoring pre-crisis growth rates should be possible — but only if economic policy is reformed to deal with three issues that have been treated as taboo, especially among central bankers:

First, central banks must be allowed to interpret their inflation targets flexibly, to ensure that monetary policy promotes growth, as well as maintaining stable prices. In support for European debtor nations that are wrestling with Germany over the ECB’s exclusively inflation-fighting mandate, Fischer insists that “in practice, even in countries where the central bank officially targets only inflation, monetary policymakers also aim to stabilize the real economy around some normal level or path.”

Second, policymakers must distinguish weak demand, which is likely temporary, from weak supply-side growth, which may well be structural. This is essentially the issue discussed last month in this column. In the United States, Fischer attributes the weakness of demand to housing, Europe and fiscal drag, and suggests that all these “headwinds” could be counteracted with better policies. Housing, for example, could be helped by avoiding a repeat of the “sharp rise in mortgage rates in mid-2013.” Reversing the drag from Europe requires resolution of the euro crisis. On fiscal policy, the obvious solution is simply to stop raising taxes or cutting public spending.

Third, Fischer points out that some of the supply-side obstacles to growth that seem structural — such as falling labor participation, low investment and weak productivity — can be caused by temporary weakness of demand rather than by permanent changes in technology or human nature.

A key objective of monetary policy is, in his view, to ensure that any temporary weakness of demand does not translate into a permanent reduction of supply by eroding work habits, discouraging investment and slowing productivity growth. “There are real risks that cyclical slumps can become structural,” Fischer said, “and it may be possible to reverse or prevent declines from becoming permanent expansive macroeconomic policies.”

As for the idea that productivity growth is permanently declining because technological ideas are near exhaustion, Fischer concludes wryly: “It is unwise to underestimate human ingenuity.”

It may also be unwise to underestimate the ingenuity of central bankers — now that they are really determined to get faster growth.

 

PHOTO (TOP): Stanley Fischer testifies before the Senate Banking Committee confirmation hearing on his nomination to be a member and vice chairman of the Federal Reserve Board of Governors on Capitol Hill in Washington, March 13, 2014. REUTERS/Yuri Gripas

PHOTO (INSERT1): Bank of England Governor Mark Carney attends the bank’s quarterly inflation report news conference at the Bank of England in London, August 13, 2014. REUTERS/Suzanne Plunkett

PHOTO (INSERT 2): European Central Bank President Mario Draghi addresses a news conference following the ECB Governing Council meeting in Brussels, May 8, 2014. REUTERS/Francois Lenoir

3 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Have the world’s central bankers succeeded so far with trillions of dollars worth of liquidity supplied to the world’s financial systems after more than five years of trying???

No. And why not? Maybe because those trillions of dollars go to all the wrong places instead of where they are needed?

It’s sort of like putting a message in a bottle (in this case, trillions of messages in trillions of bottles) and hoping that someday, some of those bottles will float over to right place.

Posted by nose2066 | Report as abusive

Japan is now back in recession. Abenomics has hit a consumer spending
wall with all the anti deflation price rises and the weak Yen also
pumping up the prices of all imported goods and materials so consumers
have stopped spending. Abe has got his higher retail prices but at the
cost of being back in a recession.

Posted by ChoshuShinsaku | Report as abusive

This is a bot like asking can a collection of drunks get global alcoholism under control. The orthodox Keynesian delusion means you are regarded as a lunatic for even asking germane questions let alone suggesting appropriate solutions.

Posted by evilhippo | Report as abusive

… [Trackback]

[...] Read More Infos here: blogs.reuters.com/anatole-kaletsky/2014/ 08/15/can-central-bankers-succeed-in-get ting-global-economy-back-on-track/ [...]