(Repeats to widen distribution)
By Howard Schneider and Leika Kihara
WASHINGTON Oct 10 Central banks' repeated
warnings that there are limits to what they can do to bolster
the sputtering world economy could suggest they are about to
pull back and pass the baton to governments.
But a steady flow of research and a new tone in the debate
among policymakers and advisers points in a different direction:
rather than retreat, central banks are preparing for the day
they may need to do more, even at the risk of antagonizing
politicians who argue they already have too much power.
The shift can be seen in the acknowledgment by Federal
Reserve policymakers that their massive $4 trillion balance
sheet will not shrink anytime soon, or that asset buying may
become a "recurrent" tool of future monetary policy. It can be
seen in the comments of Bank of England officials who talk of
crisis-fighting tools as now semi-permanent fixtures, or in the
Bank of Japan developing a new monetary policy framework, in
this case targeting long-term market interest rates.
Driving those developments is an emerging consensus among
policymakers who now acknowledge that the global financial
crisis has led to a fundamental shift toward low inflation,
tepid growth, lagging productivity and interest rates stuck near
"We could be stuck in a new longer-run equilibrium
characterized by sluggish growth and recurrent reliance on
unconventional monetary policy," Fed Vice Chair Stanley Fischer
said last week.
For years, Federal reserve and other policymakers have
discounted such a scenario, arguing that temporary factors were
slowing the recovery and plotting a return to conventional
Over the past months, though, that optimism has given way to
an admission that such a return is increasingly elusive.
Interest rates are set to stay low far longer than thought only
a year ago and jumbo balance balance sheets accumulated through
crisis-era asset purchases are now cast as a possibly permanent
At the annual Jackson Hole Fed conference in August the
discussion had shifted from the mechanics and timing of
"normalization," to how and whether to expand the central bank
footprint yet again.
Policymakers still keep reminding governments they should
help boost productivity and growth with reforms and, where
possible, spending on infrastructure.
But there has been a growing recognition among central
bankers that they may not be able to simply hand the problem
off, and that now is the time to lay the groundwork for more
aggressive policies that may be needed down the road.
Existing tools may not be enough "to deal with deep and
prolonged economic downturns," Yellen said in Jackson Hole. She
has since flagged the possibility that in a future downturn the
Fed might need to start buying private securities and not just
government bonds, a step already taken in Europe.
During last week's International Monetary Fund meeting, its
officials even challenged the decades-old consensus about the
seperation between monetary and fiscal policy, suggesting
central bankers should support government infrastructure
spending with low borrowing rates.
"The current low-interest environment provides an historic
opportunity to make these necessary investments," IMF managing
director Christine Lagarde said ahead of the meetings. Loose
monetary policy could double the growth impact of public
spending and allow the debt burden to actually fall, she said.
On Saturday, Bank of Japan Governor Haruhiko Kuroda said
such "synergy" was already factoring into the BOJ's plans.
"By continuing an extremely accommodative monetary policy,
fiscal stimulus could be even more effective," Kuroda told a
The shift has been gradual, but gained momentum this year.
Two years ago, Japanese and euro zone policy rates were
still above zero, and the Fed published a policy normalization
plan that said the balance sheet would begin to decline once
interest rates started to rise. Fed forecasts at the time
suggested rates would be on the way up from 2015 onwards.
Yet the Fed has raised rates only once since then and when
it did, in December 2015, it gave a taste of things to come. The
message was that the Fed would keep its large portfolio until
rate tightening was "well under way."
Analysts at the Institute of International Finance, the
global banking trade group, argued last week that any cuts to
the Fed's portfolio are now so far out in the future that it
serves as a form of fiscal support by keeping big amounts of
government securities off the market and rebating the interest
to the Treasury each year.
Over the past year research at the San Francisco Fed and
elsewhere has cemented the idea that demographic trends, risk
aversion, and the diminished need for physical capital in a
service economy, had created a less dynamic world economy where
it will be hard to move policy rates much above zero. In this
context, central banks' bond holdings, negative rates or even de
facto bankrolling of government spending no longer look
temporary or all that unconventional..
Still, an even larger footprint for central banks poses a
political challenge. There are legal constraints on the European
Central Bank and some German and Dutch politicians have argued
the ECB has already gone too far with its negative interest
rates and bond buying.
In the United States, Republican presidential candidate
Donald Trump has accused the Fed of propping up stock markets to
help the Democrats, and lawmakers routinely grill Fed officials
about plans to shrink the balance sheet.
Saying it will not happen until interest rates rise takes on
less meaning as the expected pace of increases slows.
Former inflation hawks like St. Louis Fed President James
Bullard, for example, no longer worry about the size of the
Fed's asset holdings.
"Five years ago I would have been saying you are taking a lot
of inflation risk," by scaling up asset purchases, Bullard said
in a Reuters interview. "There seems to be no urgency now to
reduce the size (of the Fed's balance sheet)."
(Reporting by Howard Schneider; Additional reporting by Balazs
Koranyi in Frankfurt; Editing by David Chance and Tomasz