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ERDOĞAN ALKİN

ERDOĞAN ALKİN > What’s left in the toolboxes of the central banks?

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To stimulate stagnant economies, central banks have tried their best. After using ordinary tools to convince the American people and private business to spend more, the Federal Reserve Bank is now implying that it will keep interest rates “exceptionally” low until the middle of 2015. The European Central Bank cut its benchmark rate to a record low 0.75 percent. The Bank of England restarted bond buying. However, all these acts don’t seem like they will be enough to prevent a second recession.

The FED might begin another round of bond buying. The ECB might cut its key rate to 0.50 percent during the coming months. And almost all central banks in the eurozone seem to be reducing the rate for overnight deposits to minus 0.25 percent in order to encourage banks to use money for more productive purposes.

Then, almost suddenly – in contrast to expectations that they would do more, as well as the pressure on them to curb recession risks – the chiefs of the two most important central banks, the Federal Reserve Bank of the United States and the European Central Bank, surprised markets with their somewhat unexpected announcements. The FED declined to act immediately and declared it would act as needed in the future to keep the economy growing. In addition, a short time after promising to take necessary steps to prevent a new recession, the head of the European Central Bank, Mario Draghi, said that only after the region’s governments do their best would the ECB use all necessary tools to calm the markets.

Although there are some rumors that Draghi changed his rhetoric under pressure from Germany, he might also be as hesitant as Chancellor Angela Merkel about the additional growth-boosting effects of ordinary monetary policy tools which have already been used but have remained ineffective. If these tools are used further, which means looser monetary policies, a new inflationary surge may begin before any improvement in growth begins. In the end, not only Europe but the whole world may again face a disaster which was called “stagflation” or “inflation in stagnation” in the past. If the FED is also uneasy about the probability of creating such a disaster, who can blame both central bank chiefs? The problem is the lack of new and different tools in the central banks’ toolbox to support growth while avoiding stimulating inflation.

A new idea is buying mortgage securities rather than treasury bonds to encourage lending. Another idea is that the FED, for example, could extend longer-term credits to banks using mortgages as collateral. The Republicans are against that idea because of inflation fears. There are other ideas such as cutting the interest rates paid on commercial banks’ reserves by the central banks in order to make lending to business more attractive.

A lot of new tools which have not been used yet have been the subject of discussion but there has been no concrete decision yet. Most of them are so complex that only professionals can decide whether they might stimulate growth without raising a new inflation risk. The difficulty is that if only professionals can understand these rather complex mechanisms that have not been used before, how can they convince the decision-makers to immediately implement them?

Another problem is the different nature of the American and the European problems, as well as the different central bank traditions. As a result, new tools that have been considered rational and feasible for stimulating growth without carrying the risk of inflation in the U.S. might not be accepted as practical and useful in Europe, and vice versa.

This means that it is the politicians alone who will again take the responsibility for the final decision without even comprehending the mechanism of the new tools. As such, professionals will have no right to blame them if everything goes wrong.

August/20/2012

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