Central Bankers - Unorthodox Policy Options Left In The Armory
A week ago, Mark Carney was announced as the Bank of England’s next Governor amid much fanfare. This week, Japan’s election could herald a new more aggressive approach from the BoJ. 2013 will then see speculation mount about Bernanke’s successor and also likely see the operation of the ECB landmark OMT program. It will also mark the 100 years of the Fed and probably much reflection on their impact on the US/Global financial system. So, as Deutsche's Jim Reid notes, central banks will remain in the spotlight for 2013. However whilst their actions to date have certainly minimized the tail-risk post-GFC, they have yet to lift real GDP above their 2007/2008 peak in most countries and virtually every developed economy is operating well below what is perceived to be trend growth.
So in this section Deutsche Bank discusses what new ideas might start to be debated as to what central banks can do to be more innovative if growth continues to remain subdued, or if fresh crises hit markets. QE 3 or 4 years ago would have been seen as highly unorthodox and unique for most central banks stretching back through their history. However fast forward to today, that old unorthodoxy has become the new orthodoxy. But what have the world’s central banks got left to offer a world that at some point might be hungry for more?
Option 1: Debt Monetization
In recent weeks, Adair Turner, a former front runner for the recently filled Bank of England Governorship, apparently privately raised some interesting policy ideas in his failed bid to get the nod. He argued that QE may be becoming less and less effective in promoting economic growth and that more unorthodox monetary policy measures may be called for, going so far as to discuss whether the Bank might tell the British Treasury it wouldn’t have to repay some of the £375bn of government debt it currently holds as a result of its quantitative easing program.
In truth this is not so much a new idea (for example, the German Reichsbank did it in 1921-24) as a very old and potentially very dangerous one. If central banks cancel the government debt they have bought through newly created money, they will effectively have directly monetized government budget deficits. One technical way to do this would be to roll the bank’s government debt holdings into perpetual zero-interest debt as and when those holdings mature, writing the debt off in all but name. Such a policy is extreme and a long-way off but such an outcome somewhere in the developed world might occur at some point. Maybe 2013 is too early for this but it might be tempting at some point somewhere around the world.
Option 2: Getting the Helicopter Going
Debt monetization is one rather roundabout form of Milton Friedman’s helicopter drop, where the Fed simply prints say $2000 for each and every citizen and then puts it in the mail to them. Unless the recipients save all of this $2000 it should stimulate consumer spending and/or asset prices in the economy and give growth a shot in the arm. To formalize such extreme policy it has been suggested that the governments could introduce a temporary lump-sum tax cut which is financed by issuing bonds, which the central bank buys and agrees to give all redemption payments and interest straight back to the government.
Such a policy has two issues: first is the concern it may just generate inflation with no gains to the real economy. Indeed if the central bank financed government budget deficits, and the government used this as an excuse to run ever higher budget deficits, this would undoubtedly risk a path towards hyperinflation. Second it would require a change in the relationship between many of the world’s central banks and governments and, given most central banks deep-seated opposition to the risk of high inflation, likely end the age of independent central banking. Again one to watch but maybe not for 2013.
Option 3: Changing the Central Bank’s Inflation Mandate
On the theme of redesigning central banks from the bottom up to deal with the economic challenges of the world’s economies, two other options have been discussed: (1) raising the Banks inflation targets or (2) changing these inflation target for price targets.
First, the economics. The policies derive from the economic principle that if expectations over future inflation increase then inflation will, in turn, increase. This will disincentivize individuals, firms and investors from holding cash and cash-like Treasury securities and put their money to work buying goods, building new factories and investing in equities and other riskier assets in an attempt to stay ahead of the inflationary tidal wave.
By changing the central bank’s mandate so that they target a higher level of inflation (say 4% a year) this should raise inflation expectations in the economy by the simple fact the central banks are now under orders to raise inflation if it’s below 4%. The price target is a little more sophisticated. The idea is to say that prices should grow (i.e. inflation) at 2% a year and the central bank should account for any periods where inflation is below 2% by raising inflation above 2% for a period of time until the price level is back on target. If central banks were told that prices should have increased by 2% a year since 2007 in many of the world’s economies there’d be a fair amount of catching up to do, again lifting inflation expectations.
There are two key challenges to these policies. First is they may lead to overkill on the inflation front as individuals lose faith in the central banks targets and simply assume they will continue to inflate beyond their new targets, generating un-controlled inflation. The second is that even if the central banks can control inflation at the new higher target, the gains will be nominal and not real, failing to deal with key economic problems such as real growth and unemployment. For an economy to grow, firms need to start making/providing more actual goods and services and hiring more people to do so, not simply charging more for what they were going to make anyway.
Such policies would also threaten many Government bond markets and possibly require financial repression to force more and more holdings of government bonds amongst its long-term savings and its financial institutions.
Option 4: Central bank purchases targeting a wider range of assets
A more widely touted unorthodox monetary policy is for central banks to begin buying assets other than government and government agency-backed securities. Whilst current QE purchases have an indirect effect on other financial assets by driving the yields down on government bonds, a more direct approach would be, well, more direct. Central banks could begin buying more long-term government debt, corporate debt, real estate or even equities to stimulate the economy. This is less a brand new policy but rather simply replacing the current QE gun with a bigger brother.
Option 5: Intervening in FX markets to weaken the currency
As with monetary deficit finance, central banks intervening to weaken their currencies to promote the growth of export industries not new and unorthodox. Both the Japanese and Swiss central banks have intervened directly in FX markets to weaken what they saw as an overvalued home currency. A problem that many central banks have found when attempting to weaken their currencies is that they have been overtaken by events: attempts to weaken their currency have been more than offset by investors fleeing risk in other parts of the global economy (e.g. the Eurozone crisis). The other problem is that not every economy can have a weakening currency as each currencies value is determined relative to other currencies. So, for example, large US intervention to weaken the dollar would, if unanswered, strengthen the Euro and Yen etc. Could 2013 be a year where competitive attempts at devaluations increase?
Outside of FX intervention, the policies discussed above are well outside the mainstream of economic thinking and/or have been deemed by policy makers to pose more dangers then benefits. However as the world economy peers into the future and sees a growing threat of a recurring recessions and below target inflation, radical monetary policy may become increasingly appealing as elected politicians stuck in gridlock turn to (relatively) politically unconstrained central bankers to save them from their failings and get their economies racing again. For better or for worse.
Evidently - one word comes up again and again - inflation (and long with it - uncontrollable); which merely supports the holding of hard assets as wealth preservation...
Source: Deutsche Bank
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