By Howard Schneider
NEW YORK (Reuters) – The raft of programs rolled out by central banks to fight recent economic crises, from massive bond buying to negative interest rates, had mixed success at best and may do even less the next time around.
That’s the conclusion from a group of top economists in a study urging a deeper rethink among central bankers about how to fight the next recession.
To be most effective, the group said, policymakers need to say clearly what they intend to do in the next downturn, and then act fast and aggressively when the time comes – precisely because their tools appear less effective the more economic conditions deteriorate.
Central bankers “should be prepared to deploy the new monetary policies early and aggressively, when it is still feasible to stabilize prices and economic activity,” the group concluded. The “limited success” of earlier programs, which they found worked fewer than one in three times, is “a justification for more activist policy not less.”
Even then, they said, policymakers should “be humble about their likely effectiveness” in offsetting a deep downturn.
The study was written by a group of veteran monetary policy analysts including JP Morgan chief economist Michael Feroli, Citi chief economist Catherine Mann, and former Bank for International Settlements economist Stephen Cecchetti. It was released at an annual University of Chicago Booth School of Business forum on monetary policy.
It comes amid a period of intense reflection among global central bankers over how they responded to crises, and what influence they still wield over a global economy in which interest rates are anchored at low levels and the economies of major countries deeply intertwined.
If anything, the group said, central bankers perhaps need to go further then they currently intend in a new playbook for handling economic downturns. In particular they encouraged the Fed to be explicit in its planning as part of a policy review already underway.
Traditionally, raising and lowering short term interest rates was the mainstay tool of monetary policy, with higher rates curbing activity and lower rates encouraging borrowing and spending. Recent research has already suggested policymakers could get more bang for the buck from rate cuts if they moved faster and cut deeper.
But rates are so low now that policymakers also worry they will inevitably have to resort to the once “unconventional” tools deployed at the onset of the 2007 financial crisis and since. That has included buying trillions of dollars of bonds through “quantitative easing” in the U.S., Europe and Japan, strong statements or “forward guidance” to steer markets, and other methods, including the use in Japan and Europe of interest rates below zero.
Fed Gov. Lael Brainard said in a prepared commentary on the paper that the call for faster action made sense, since central banks that delayed using unconventional tools seemed to get less impact from them.
“We should clarify in advance that we will deploy a broader set of tools proactively,” once rates hit zero, she said.
Controversial at first, conjuring fears of inflation or financial instability, those tools have earned broad political acceptance — to the point where usually conservative Republican lawmakers in the U.S. goaded nominees to the Fed at a recent hearing to say they’d be ready to use them if needed.
The bad news: the tools may not be all that robust.
Many studies have been done, for example, of how effective Fed quantitative easing was in lowering borrowing costs, and generally concluded that at least the initial rounds of Fed bond buying made credit cheaper and helped the economy.
The new study tried to be more global and more systematic. The researchers created unique measures of financial conditions for major developed nations and for the world as a whole, and looked at whether the different crisis programs improved the climate for households to get credit, and for companies to borrow money, issue bonds, or sell stock.
“Our first high-level takeaway…is that the glass is half-full,” the group wrote, since in just under a third of 84 instances where “new monetary policies” were put in place, financial conditions eased significantly. “This is evidence of central bankers’ ability to affect financial conditions,” even after the main target interest rate is cut to zero and cannot be lowered further, the typical point at which less conventional methods are employed.
“The second high-level takeaway is that the glass is half-empty: in many cases, the new monetary policies were not sufficient to offset whatever other factors were leading to tighter domestic financial conditions,” they wrote. “Monetary policy as implemented was not enough.”
Some things seemed to work better than others, they said, and noted particularly measures like the Fed’s 2012 promise to keep interest rates at zero until the unemployment rate fell below 6.5%. Tying a policy promise about interest rates to a specific economic outcome, the group found, was “arguably the most successful tool to affect domestic financial conditions,” and worked in four of six countries where it was used.
But overall, the group said, the results of their study “counsel against complacency.” The impact of global financial conditions on each individual country was deep, they noted, leaving the Fed and other central banks somewhat tied at the hip.
With future recessions likely to be synchronized across countries “the importance of global financial factors suggests that any individual central bank—even the Federal Reserve—may be battling forces over which they have limited influence.”
(Reporting by Howard Schneider; Editing by Chizu Nomiyama)