Fed and ECB Are Stuck in a Shrinking Corner
(Bloomberg Opinion) -- The European Central Bank and the Federal Reserve will be under even greater scrutiny over the next 10 days as their policy-making committees discuss recent economic developments, update their assessment of prospects and adopt whatever actions and guidance they deem necessary. The outcome will most likely satisfy those looking for the world’s two most influential central banks to further loosen monetary policy. It will most likely do little to improve what has been a steadily darkening outlook for the global economy. And it will without a doubt disappoint those, both inside and outside the central banks, who are looking for the spotlight to pivot away from monetary policy to structural reforms and, for some European countries, fiscal tools that are better suited for the task at hand. Indeed, it could well only intensify the spotlight on monetary policy, making even more explicit the increasingly tight corner these institutions are in.
Don’t get me wrong. Most central banks, and the many of us who still have deep respect and affection for them, would like nothing more than for them to deliver better economic outcomes or hand off efforts to bolster the global economy to others or both. The best that we can hope for, however, is that they will be able to navigate the minefield they are in without being accused of not doing enough, of causing economic harm and of contributing to undue financial volatility. Indeed, the most likely outcome is that they will be viewed as taking measures that are deemed ineffective or, even worse, counterproductive. And it’s a dilemma that is unlikely to be resolved soon.
This is an ironic situation for central banks. On paper, they have powerful tools at their disposal such as political autonomy, talented staff members and partial control of the amount and cost of money. This allows them to respond quickly, to modify the behaviors of households and businesses and to be bold when needed. But because their exceptional actions over the last decade have not been supported by proper responses from other policy-making agencies, they have instead contributed to their current dilemma. And the more alone the central banks remain in front, the happier markets and governments will be to delegate more of their responsibilities to them and the more that will be expected from them.
Simply put, it is becoming increasingly difficult for central banks either to move forward or to go back. It’s a dilemma that has played out particularly loudly in public over recent weeks. Consider the Fed, whose policy complexities, while significant, pale in comparison to those of the ECB. On the one side, President Donald Trump has repeatedly attacked the Fed for not doing enough to support his growth agenda while on the other, Bill Dudley, the former president of the New York Fed, the most powerful of the system’s regional banks, has criticized it for doing too much. Diametrically opposing views have also been publicized from inside the Fed, with some Federal Open Market Committee members arguing there is no need for an interest rate cut this month and others advocating a 50 basis point reduction.
Which takes us to the ECB. Unlike the Fed, it’s confronted by unambiguous evidence of rapidly declining economic momentum. As such, it is under market pressure to cut interest rates further into negative territory this month and to resume large-scale asset purchases in the next few weeks. With investors having already priced in such steps, failure to follow through would most likely cause financial volatility that risks undermining an already fragile regional economy. Yet few expect such actions to materially improve the euro zone’s economic prospects for a simple reason: A further loosening of financial conditions does nothing to help eliminate the structural and cyclical impediments to growth.
Even worse for the ECB is a slowly spreading view that warns of the outright costs of further monetary policy stimulus. The crux is that the persistence of negative interest rates eats away at the integrity of a well-functioning market-based economy by constraining bank credit, encouraging irresponsible risk taking by non-banks, discouraging the provision of financial protection products that are an important part of a household’s financial security and causing misallocation of resources.
All of this puts the ECB in a bind, and not just for its meeting later this month. It can either risk financial and economic dislocations from disappointing investors that are hooked on ample and predictable central bank liquidity or deliver on market expectations only to risk doing more harm than good to the economy.
The good news is there is a way out of the mess. The bad news is that it requires political will and courage at the national, regional and multilateral levels that so far has been elusive. Absent a significant fiscal commitment from governments and other policy makers, the central banks’ dilemma will only become more acute.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
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