Schooled in the short run, central banks struggle with a long-term role
JACKSON HOLE, (Wyoming): Schooled in economic thinking that confines monetary policy to the short run, central bankers gathering in Jackson Hole, Wyoming, are grappling with a singular change: whether they can take over as guardians of long-term growth with programmes that may stay in place and influence markets for decades to come.
The debate, being carried out in technical research and policy forums like the annual meeting here, could herald a break with decades of central bank orthodoxy which has relied on short-term interest rates as the main policy lever in favour of a host of unconventional tools — from outright targeting a certain level of growth, to the permanent use of negative interest rates or massive cash infusions to stimulate inflation.
The discussion has already seen some Fed policymakers radically shift their view of monetary policy, and will be more broadly joined on Friday when Federal Reserve Chair Janet Yellen delivers the opening address to the Fed's annual policy conference here.
Though watched for clues to whether the Fed is likely to raise rates in the near future, the announced subject of Yellen's speech is the Fed's policy "toolkit," and may give insight into how deeply she feels policy should be overhauled in light of what has been learned since the 2007-2009 financial crisis and recession.
Policies put in place then have largely remained intact, much to the surprise — and chagrin — of officials including Yellen, who have expected the United States and world economies to return to a pre-crisis "normal" once various "headwinds" diminished.
Instead, the emerging vision is of a changed world where expected growth is lower, deflation remains more of a risk than rising prices, businesses hesitate to invest and individuals' views of the future are so fully "anchored" it becomes hard to nudge them toward, for example, higher inflation.
With the impact of monetary policy muted in its short-run effect on growth, and governments globally leaving a vacuum on longer-term issues like better fiscal and productivity policies, central bankers are struggling over whether and how to step into a different, long-term role.
"When I left the Fed at the beginning of 2009 we talked about having interest rates at extraordinarily low levels for some time. I don't think anyone thought 'for some time' was going to bring us six, seven, eight years later," said Randy Kroszner, a former Fed governor and now an economics professor at the University of Chicago Booth School of Business.
"If central banks are being asked to do some longer-run kinds of things, what is the right framework...what is the balance sheet, what are your targets, what are the tools?"
It is a revolutionary question. Disagree as they might, central bankers have a rough consensus on one thing: that monetary policy works in the short run, and does not have an impact on long-term growth and productivity dynamics.
Not just lower
Negative interest rates have become part of crisis policy in Europe and Japan, but mainstream economists are beginning to pave the way for them to become permanent policy options.
Some $8 trillion of sovereign debt has negative yields and central banks across the globe own $25 trillion of financial assets — a sum larger than the economic output of Japan and the United States combined — according to Bank of America research.
Discussion has even turned to whether central banks should drastically scale back the amount of physical cash in circulation so mattress-stuffing and massive withdrawals can't be used as a way to blunt the effectiveness of negative rates as a tool to stimulate investment or spending.
It's uncertain how far the debate will go in terms of influencing policy. Fed and European officials have urged fiscal policymakers to do more precisely because they feel monetary policy is of limited long-run impact.
And Fed officials generally argue that they can even respond to another recession by relying on the same combination of quantitative easing and forward guidance they used last time.
But there's also a sense that the good old days — when short-term interest rates were all that mattered and central bankers felt they knew what to do with them — may not come back.
Fathom Consulting deemed it "the end of monetary policy," while Goldman Sachs analysts David Mericle and Daan Struyven said that as it stands the Fed may be painted into a corner.
Quantitative easing may not work in any future crisis, and if markets have lost faith in the Fed, forward guidance won't either.
"These concerns might well be a key theme both at Jackson Hole and in Fed commentary in the coming year," they wrote.