The recession scare at the beginning of the year was an unpleasant reminder of how empty the central banks' armoury has become. Even if the Fed manages to push interest rates to a meaningful level, say 2%, this leaves only modest conventional monetary policy firepower to address any future slow down. 2% interest rates seem a long way away in the States and an eternity away in Europe and Japan. With bond yields where they are, further rounds of QE are likely to be impotent, this is the archetypal 'pushing on a string' situation.
The Bank of Japan surprised markets in January by joining the ECB and the Swiss National Bank in imposing negative rates on excess reserves. Financial markets have been unimpressed by these moves, and banking share prices have suffered as markets have digested the implications for net interest rate margins. Quite how far rates can fall into negative territory remains uncertain, but if they keep falling at some stage it will become cost effective to hold cash in hand rather than on deposit. As a home owner, I rather like the idea of receiving a monthly interest payment from my mortgage bank. Mind you, if interest rates ever fell that low, there would be no hurry to cash the cheque.
Underlying some of the recent market turbulence has been a growing perception within some quarters that central banks are running out of effective policy options. But there remain a number of 'unconventional' options available. Prior to his days at the Fed, Bernanke was an academic who made his name in a seminal article that set out the actions that Japan could employ to avert deflation taking hold. These included:
• Open market purchases of private real assets such as stocks, bonds or real estate. The ECB has started to include corporate paper within its QE programme. The BoJ has been buying Japanese ETFs and REITs, but as yet not in material size
• Purchases of foreign government debt
• Ultimately, Milton Friedman's concept of 'helicopter money' could be employed and freshly printed money sent to the Exchequer to finance expenditure or tax cuts. In extremis, these could be remitted directly to households; bank accounts
Bernanke's paper underlined that sentiment has a key role, if people don't believe that prices will fall across the economy, then there is a good chance that they won't. Central banks still have plenty of tools that they can try (if permitted by their political and legal masters) to keep deflation at bay. Will they get desperate enough to use them?
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