How the Skeptics at Central Banks Could Be Vindicated

(Bloomberg Opinion) -- Just when it looked like big central banks were swimming in the same direction, they are starting to come apart.

The gaps this time are not explained simply by inflation or employment, but are driven by the international outlook and how that may affect domestic economies differently.

Central banks all have domestic mandates, but the world is so inter-connected and capital flows so freely that to meet those mandates they must rely on forecasts and risk assessments about the world at large. That’s how trade wars and emerging-market tumult made their way into recent pronouncements from the Bank of Japan, the European Central Bank and the Bank of England. If they’re feeling nervous, they could sustain stimulus or keep interest rates lower than had been expected.

The main outlier is the Federal Reserve, whose policy makers meet next week to set interest rates. The Federal Open Market Committee is unlikely to publicly fret as those other big central banks have; the U.S. economy is too strong to halt gradual increases in rates.

The BOJ’s statement this week listed international factors as the top of the risk list. Officials faulted protectionism and American policies — read “Donald Trump’s tariffs” — along with emerging-market upheavals. I don’t see the Fed saying anything like this; instead, some tweaks to the press release are conceivable.

The ECB last week reduced its growth forecasts a touch. In President Mario Draghi’s introductory remarks at his press conference, he listed trade, emerging markets and financial market volatility as gaining “more prominence recently.”

A speech last week by Lael Brainard, a Fed governor, showed how far ahead the Fed is. It wasn’t just the content, which was broadly hawkish, but that Brainard had just a few years ago carved out a role as intellectual leader of the Fed’s dovish wing.

Brainard focused on definitions of neutral, the interest rate that neither stimulates nor restricts the economy. She said that short-term neutral may be higher than over the long term. The implication is that the Fed needs to focus on what the domestic cycle is telling us and that rates can move above neutral if need be. Sure, she’s watching global developments, but they warranted one paragraph in the 11-page address in Detroit.

The scene outside the U.S. was the very last piece of the Fed’s August statement, right before the votes of FOMC members. It’s probably premature for the Fed to elevate it, though a mention could be slipped into the second paragraph where the Fed described risks as appearing “roughly balanced.”

The Fed has altered course in the past based on international happenings. It began 2015 and 2016 foreshadowing multiple rate increases only to manage just one each year, largely because global growth was too soft. The most articulate advocate of going slow was none other than Lael Brainard.

This time will the U.S. just leave those nations behind? Let’s look at that single paragraph from Brainard in Detroit.  Here’s its final sentence: “Although capital flow reversals have been contained to several notably vulnerable countries so far, I am attentive to the risk that a pullback from emerging markets could broaden.”

If it does, the U.S. can’t remain an island. Caution and slower rate increases would most likely be necessary — proving Japan and the ECB were prescient.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Daniel Moss writes and edits articles on economics for Bloomberg Opinion. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.

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