Monetary Policy—Past is Prologue, or is It?
January 31, 2020
Odds are the average person does not spend a lot of time thinking about monetary policy, but what central banks have done over the last decade should not be overlooked or taken for granted. Economically speaking, this past decade will go down in history as being the decade of central bank intervention and muted inflation. The term “whatever it takes” to keep economies from collapsing became a common theme, as central banks everywhere took aggressive measures and introduced controversial new programs of which the effectiveness and long-term consequences will be debated for years to come.
During this time, we had three different chairmen of the Federal Reserve in the U.S. “Helicopter Ben” Bernanke guided us through the first few years of the decade as the Fed kept interest rates at zero and the balance sheet swelled from about $800 billion to over $4 trillion, the largest in history by far, as they fired up the money printing press of quantitative easing (QE). In 2014, Janet Yellen became the first female to head the central bank in its 100-year history as the Fed embarked on three years of rate hikes. Then in 2018, Jerome Powell took over and ushered in a series of additional rate hikes, followed by three rather abrupt rate cuts. These three individuals had tremendous influence over the capital markets and the general economy, which is currently enjoying its longest expansion in history.
Most likely, there will be a price to pay for years of easy monetary policy that have left us with rock bottom interest rates and piles of new debt. With the fed funds rate at 1.75% today, there is little room for the Fed to respond by cutting rates when the next downturn arrives. Moreover, outside of the U.S., much of the developed world has been living with negative interest rates for many years now, a figure that ballooned to $17 trillion at its peak last summer. It could certainly be argued that, at current levels, this strategy has become counterproductive. In fact, many economists acknowledge that monetary policy seems nearly exhausted, and that fiscal policy, via government spending and taxes, will probably need to come to the forefront if more stimulus is ever needed. This could mean that economic policy is at an inflection point.
We feel confident in saying that negative interest rates are not the answer, and it is very unlikely that the current Federal Reserve would implement such a policy. Support for fiscal easing is rising and economists argue that, with bond yields below the overall level of GDP growth, debt is more affordable today. In the U.S., there has been talk of further tax cuts for the middle class, which wouldn’t be surprising in an election year, but nothing has been officially presented yet. The challenge is that fiscal policy takes time to enact and requires laws to be changed by government institutions. Thus, we are unlikely to see an immediate regime shift from monetary to fiscal policy. However, over the course of the next decade, we will likely see more stimulus coming from fiscal policies.
As for what to expect this year, in our view, it is unlikely we will see dramatic changes in policy. While there is not much room for interest rates to fall further, there is also little reason to expect that rates will move significantly higher either. Meanwhile, most developed market central banks have re-started easy monetary policies and central bank balance sheets are expanding once again.
The Federal Reserve is currently conducting an in-depth review of their policy toolkit and studying ways to alter their strategy and develop tools that can work when interest rates approach zero. In this regard, navigating an economic downturn will not be easy and we will need innovative thinkers and coordinated policy to guide us through the next decade.
Sources:
www.federalreserve.gov
www.bloomberg.com/graphics/negative-yield-bonds
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