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The Search for Growth


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The Search for Growth

  1. 1. The searchfor growthCentral banks inuncharted territoryA report from the Economist Intelligence Unit Sponsored by
  2. 2. The Search for Growth Central banks in uncharted territory Contents 1 Introduction 2 2 The critics 4 3 The defenders 6 The euro zone 6 4 The future 8 A larger role for emerging-market central banks? 8 5 Conclusion 101 © The Economist Intelligence Unit Limited 2012
  3. 3. The Search for Growth Central banks in uncharted territory 1 Introduction The European Central Bank (ECB) created a small bankers remain so prevalent, investors interviewed sensation in August when it said that it was pointed to the long-standing respect for central considering buying unlimited amounts of bankers in the financial world and their assumed government bonds in order to cap the yields on the detachment from politics. Others suggested that debts of Spain, Italy and other beleaguered euro central banks have indirectly benefited from the zone states. A month later, the US Federal Reserve dim view that many institutional investors and announced a third round of quantitative easing corporate leaders have taken of governments’ that it said would end only when economic performance following the financial crisis. Only conditions improved. The two announcements were 36% of survey respondents said they were widely anticipated; two years ago, they would have confident of governments’ ability to make the right been unthinkable. decisions. In their ongoing response to the aftershocks of But the vast and fundamental changes in the❛❛ the global financial crisis, central banks are role of central banks have unlocked a host of Central banks are abandoning the narrow role they traditionally questions about the wisdom and impact of theseabandoning the played in economic affairs. In developed economies changes. Some give credit to central bankers fornarrow role they in particular, they have greatly expanded their averting financial catastrophe and preventing atraditionally direct participation in financial markets, working to much deeper economic slump—a point that theplayed in sway investor sentiment and restore confidence. Federal Reserve chairman, Ben Bernanke, himselfeconomic affairs. Much of this shift has been reluctant, and arguably made at the Fed’s annual symposium in Jackson❜❜ it is spurred by lack of government action to Hole, Wyoming, in early September. But questions stimulate the global economy or correct structural remain about the wider role central banks have imbalances. But many observers expect the changes assumed since then. Others blame central banks for to be permanent. creating the conditions that led to the 2007-08 Through it all, institutional investors and meltdown, and doubt they have fundamentally corporate executives have maintained relatively rethought the policies that preceded it. Some high confidence in central banks. In a survey by the criticise central bankers for being too Economist Intelligence Unit of over 800 investors accommodating of large financial institutions. and corporate leaders conducted in January 2012 Others accuse them of enabling improvident and sponsored by BNY Mellon, 54% expressed governments to continue to run up large deficits confidence in central banks’ handling of monetary that have destroyed confidence in long-term policy, up from 51% in 2011. economic recovery and of causing market Asked why overall positive views of central distortions as a result of their accommodative2 © The Economist Intelligence Unit Limited 2012
  4. 4. The Search for Growth Central banks in uncharted territory interest rate policies. There are also unanswered in-depth interviews with nine prominent questions about how long central banks will retain economists, analysts and portfolio managers. the wider role they have carved out for themselves, These experts expressed a wide range of views. and if they even have a choice in the matter. Some were especially critical of central bank action To examine these questions and to better over the last four years. All had pointed opinions understand the challenges facing central banks in about the role central banks should assume in the the post-recessionary period, the EIU conducted future.3 © The Economist Intelligence Unit Limited 2012
  5. 5. The Search for Growth Central banks in uncharted territory 2 The critics Most observers agree that central banks cannot of 2000. This engendered global investors’ “search restore a healthy global economy by themselves. for yield” that helped to create the housing bubble But they disagree on where to place the blame for and overinvestment by European banks in the current crisis, and on their critiques of current peripheral economies like Greece. Mr Schiff central bank policies. There is deep disagreement expressed these views as early as 2006, and was about what specific actions governments need to interviewed extensively post-financial crisis as take, and whether central bank policies might be being the “man who got it right”. But low interest hindering governments from taking those steps. rates were not the root of the problem, points out There is also concern that central banks may be Ethan Harris, co-head of global economics research subjected to greater political wrangling. At the at Bank of America Merrill Lynch. Mr Harris, who❛❛With so many Jackson Hole meeting, some expressed fears that worked at the Federal Reserve Bank of New York for the Fed could be pressured to extend its nine years, believes that the main failure of theregulators—both accommodative interest rate policy or even to Fed, and other regulators, was weak regulation offederal and state- compromise its independence by subjecting its the subprime mortgage market. “With so manylevel—overseeing monetary policy to regular audits. regulators—both federal and state-level—different parts of Central banks’ strongest critics argue that easy overseeing different parts of the market, it wasthe market, it was credit policies, while perhaps justified in the unclear who was really in charge,” he says.unclear who was immediate aftermath of the 2008 crisis, now The most dangerous consequence ofreally in charge. threaten long-term economic recovery and maintaining a low interest rate environment, stability. The critics also accuse central bankers of according to critics like Mr Schiff, is that it distorts❜❜Ethan Harris, co-head of having failed to notice the formation of the the pricing of supposedly risk-free governmentglobal economics research, housing bubble that led to the crisis and then debt—and, by extension, the pricing of the manyBank of America Merrill Lynch failing to appreciate the extent of the collapse other assets that are directly or indirectly based on until it was too late. Furthermore, the central a risk-free rate of return. This facilitates the banks did not learn the appropriate lessons from formation of asset bubble in many areas, most the period leading up to the crisis—although there notably in government debt. Once investors grasp is disagreement about the substance of those this, Mr Schiff suggests, they could retreat en lessons. masse from bonds to equities and “other assets Peter Schiff, CEO of Euro Pacific Capital, argues that are in scarce supply”. Jason Hsu, co-founding that the Fed, the Bank of England and others principal and CIO at Research Affiliates in Newport maintained a low interest rate policy for too long Beach, California, believes that new asset bubbles after the recession following the collapse are forming today. He warns that investors in4 © The Economist Intelligence Unit Limited 2012
  6. 6. The Search for Growth Central banks in uncharted territory Nothing’s risk free: Central bank base rates European Central Bank (%) Bank of England Federal Reserve 7 6 5 4 3 2 1 0 February-00 June-00 October-00 February-01 June-01 October-01 February-02 June-02 October-02 February-03 June-03 October-03 February-04 June-04 October-04 February-05 June-05 October-05 February-06 June-06 October-06 February-07 June-07 October-07 February-08 June-08 September-08 January-09 May-09 September-09 January-10 May-10 September-10 January-11 May-11 September-11 January-12 May-12 September-12 Source: Bank of England, European Central Bank, Federal Reserve. search of higher returns are shifting some of their guard against another bubble forming, their failure holdings into precious metals and high-end real to prevent the last credit bubble in 2003-07 has estate in emerging markets, bidding up these dented their claims to prescience. investments and threatening to “export” inflation Mr Schiff warns that central bank efforts to lower to these markets. interest rates are also enabling governments to If these imbalances result in inflation in the delay needed cuts in spending. Low rates augment emerging markets, some believe that they could the temptation for investors to shift from the most have a global feedback effect. Warwick McKibbin, troubled markets, such as Greece, Spain and Italy, professor of economics at Australian National into high-rated sovereign debt such as US University and a former board member of the Treasuries, British gilts, German bunds and Reserve Bank of Australia, who has made this Japanese government bonds. This enables the argument, believes that inflation is going up favoured governments to sell their debt at ultra- everywhere except in the US and that “it will go up low rates, which in turn encourages them to in the US over the next six to 12 months”. While continue to fund deficit spending without suffering central bankers insist they now have the tools to any consequences.5 © The Economist Intelligence Unit Limited 2012
  7. 7. The Search for Growth Central banks in uncharted territory 3 The defenders The central banks have few defenders on some trading loss for JP Morgan Chase, appeared to counts, particularly their failure to respond to a confirm these fears. The defenders are far less metastasising financial bubble prior to 2008. There inclined to believe the central banks’ policies are is considerable scepticism that central banks and fuelling another disaster; many, however, believe their regulatory counterparts are doing enough to that the banks may retard recovery through police large institutions. The ‘London Whale’ excessive accommodation of big banks. episode in May 2012, which resulted in a US$5.8bn In the central banks’ defence, these experts The euro zone The euro zone is at the epicentre of most experts’ concerns survival of the euro zone. He terminated the Securities Markets about a mismatch between fiscal and monetary policy. Dan Programme (SMP) and replaced it with a pledge to buy Steinbock of the India, China & America Institute described unlimited quantities of one- to three-year bonds from the response to the crisis in Europe as being like fixing a plane European governments, in conjunction with the rescue fund, in mid-air. In the second quarter, the euro zone economy the European Stability Mechanism (ESM). This moves the euro contracted at an annualised rate of 0.7%—a figure that might zone considerably further down the road towards more have been worse save for a weak but positive performance by centralised control of individual countries’ economic policy. To Germany. receive the assistance, however, governments must agree to a Despite the constraints of its mandate, the ECB has done “macroeconomic adjustment programme” with the ESM. It more than is sometimes recognised. Given the unwillingness of remains to be seen whether the Spanish and Italian creditor euro members, led by Germany, to commit sufficient governments will be willing to do this, although the markets resources to bailout funds, the ECB is the only institution with may force their hands. the firepower to ease the funding pressures on peripheral The euro zone is edging, slowly, towards a comprehensive sovereigns and banks. But according to its mandate, the ECB is plan that could stabilise the single-currency zone. But the charged with only maintaining price stability (unlike the Fed, process remains painfully slow, and the risk in coming months whose mandate also encompasses employment) and direct of a market-induced shock—which could drive one or more financing of governments by the ECB is expressly forbidden by countries (starting with Greece) out of the euro zone—remains EU treaties. high. This, then, is a race between euro zone authorities and In early September, the ECB’s president, Mario Draghi, the markets, and it is by no means clear that the governments made good on a promise to do whatever it takes to ensure the will win.6 © The Economist Intelligence Unit Limited 2012
  8. 8. The Search for Growth Central banks in uncharted territory note that once the disastrous chain of events early years of the Great Depression into the 1950s. began in September 2008, the Fed stepped in Japanese rates have been low since the real estate strongly to assure liquidity and prevent a market bubble burst in 1990. collapse. They also take issue with the argument Mr Galbraith believes that interest rates are that central banks may be facilitating the likely to follow the same pattern this time. formation of new asset bubbles. According to Consequently, he dismisses fears that they will James Galbraith, Lloyd M. Bentsen Jr. chair in shoot up in the near future, ratcheting up public-❛❛ government and business relations at the sector borrowing and debt-service costs toThe Fed should University of Texas’s Lyndon B. Johnson School of economically crippling levels. “The entiresqueeze the Public Affairs, such arguments do not take full exaggerated concern over projected budget deficitsmargins on the account of the depth of the recession that began in in the US is premised on the idea that short-termbanks to get them 2008. Mr Galbraith notes that even after multiple interest rates will go back to 3-6% in the next fiveto take more risks rounds of quantitative easing by the Fed, the ECB, years,” says Mr Galbraith, “Come back in 30 yearsin the real the Bank of England and the Bank of Japan, the and see if we’re out of this yet.” In his scenario,economy. risk of asset-fuelled inflation remains far lower government debt costs remain low, keeping deficits than that of a Japanese-style cycle of debt under control and creating new opportunities for❜❜ deflation in the developed economies. governments to invest in infrastructure, education,James Galbraith, Lloyd M.Bentsen Jr. chair in Mr Galbraith and others disagree that today’s and other long-term economic building blocks.government and business low-interest environment is destined to end soon, However, Mr Galbraith is one of several expertsrelations, University ofTexas’s Lyndon B. Johnson or is even unusual for a period of sluggish growth— who argue that central banks should do more toSchool of Public Affairs. or that it is necessarily all the central banks’ push banks to restart lending. Accommodative handiwork. Christopher Reicher, a researcher at policies by the Fed and the ECB allow banks to the Kiel Institute for the World Economy focused on hoard capital rather than use it to give consumers the effects of monetary policy, notes that recession and businesses more access to credit. In the US, and depression have typically resulted in low- “the Fed should squeeze the margins on the banks interest regimes that can last for many years. to get them to take more risks in the real Interest rates remained low in the US from the economy,” argues Mr Galbraith.7 © The Economist Intelligence Unit Limited 2012
  9. 9. The Search for Growth Central banks in uncharted territory 4 The future Most experts agree that the more fundamental term fiscal adjustments,” says Dan Steinbock, problems facing the global economy are political, research director of international business at the not monetary, and that governments are best India, China & America Institute in New York. “The positioned to address them. They disagree US needs a debt-and-deficit deal, but the elections significantly, however, on which problems are have contributed to an even more polarised more urgent and what measures governments environment, while in Europe they don’t have the should take. institutional design to support that kind of action.” The US and the euro zone need “credible, long- Mr Galbraith, who calls concerns over the size of A larger role for emerging-market central banks? For some time, fast-growing emerging economies—particularly the ECB, is still years away, according to Mr Jadresic, echoing in Asia—have been demanding a larger voice within the the views of other experts. The PBOC still plays a bifurcated multilateral bodies overseeing the global financial system, role, believes Mr McKibbin, managing the national economy such as the IMF and the World Bank. While the developed and managing complex exchange-rate relationships with the economies are reluctantly accepting this new order, over time US and other trading partners. Until the renminbi is unpegged it will become harder to resolve global issues without the from the US dollar and becomes a more widely held currency, participation of central banks from the emerging economies. the PBOC will not exercise a larger role in managing the global These institutions are now better able to assume the role monetary system. because their ability to manage monetary policy has matured The PBOC is only moving very slowly in this direction. and thus inspires greater confidence, observes Mr Reicher. He Foreign-exchange trading centres for the renminbi are still believes the decline in Brazil’s long-term interest rates indicates few—London established one only in January. Some experts that its economy may be moving beyond a long boom-and-bust believe it would be a mistake for China to seek a larger global cycle, although rates in Brazil remain high in comparison with role too quickly for its central bank. Mr Hsu notes that China’s most industrialised countries. Central banks in China, Brazil, banking sector is still dominated by state-owned entities that South Africa and elsewhere have also received high marks for have a different relationship with the central bank than in their response to the 2008 financial crisis. Most experts approve other countries. The PBOC itself is less transparent in its of the efforts of the People’s Bank of China (PBOC) to control a operations than its counterparts in the developed world and it potential bubble in the country’s housing market. has considerably less institutional memory as a global currency A larger role for the PBOC, comparable to that of the Fed or manager.8 © The Economist Intelligence Unit Limited 2012
  10. 10. The Search for Growth Central banks in uncharted territory US budget deficits “hysteria”, argues that governments in many developed countries are continued focus on central bank policy has become paralysed by political gridlock, preventing decisive “a big efficiency loss”, distracting from measures action in either direction. So long as government that could revive economic growth, such as raising policy remains stymied, Mr Harris argues, central the minimum wage, making room for younger banks can, and probably should, continue to search workers by making early retirement easier for their for means within their power to spur growth, “even older counterparts and exploiting new, cleaner if it isn’t particularly effective”, as a way to energy sources. maintain a degree of confidence. Both arguments underscore the fact that9 © The Economist Intelligence Unit Limited 2012
  11. 11. The Search for Growth Central banks in uncharted territory 5 Conclusion Most experts give central banks high marks for global financial markets. “The Fed, which was tempering what could have been a far worse global created as a lender of last resort, is now also a financial crisis in 2008 and providing breathing provider of liquidity and a dealer of last resort,” room for governments to reach agreement on comments Jeffrey Cleveland, senior economist at measures that would build a stronger and more Payden & Rygel in Los Angeles. durable long-term economic recovery. Absent such The Fed and the ECB “won’t return back to their measures, however, central banks have found pre-crisis stance,” he says, “where the Fed, for themselves stuck with the job of propping up the example, was minimally invasive in markets, mostly recovery, often through measures that, some tinkering with the federal funds rate as the critics believe, could be setting the scene for situation called for.” In particular, he anticipates inflation and further asset bubbles. that the Fed will retain an active role in the Will central bankers be able to raise interest commercial paper and repo markets—major rates and withdraw other supports from the segments of the shadow banking system. The ECB, financial sector before another crisis of this sort too, he expects will be a very different institution, takes hold? “Central banks have made mistakes, assuming a role much closer to the Fed’s than its but from a medium-term perspective I expect them original, narrower focus on currency management. to do the right things,” says Esteban Jadresic, chief The West’s problems—high unemployment, economist and global investment strategist at creaking infrastructure, unsustainable healthcare Moneda Asset Management and a former adviser to and pension costs, and the need to move to greater the board of the Central Bank of Chile. “I’m more federalism in the euro zone—are structural. While concerned about what other policymakers— monetary easing will provide some relief, it is no governments, parliaments, euro zone leaders—will panacea, and it is unable to galvanise the global do,” he adds. economy alone. Solutions require political Central banks nevertheless are unlikely to pull compromises that are not within central banks’ back from the more prominent role they have powers to devise but that are proving elusive amid carved out for themselves post-2008. This has less polarisation in Washington and the stand-off to do with the recent crises and lack of government between the creditor core and debtor periphery in action than with the growing complexity of the the euro zone.10 © The Economist Intelligence Unit Limited 2012
  12. 12. The Search for Growth Central banks in uncharted territory Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this white paper or any of the information, opinions or conclusions set out in the white paper. The following regulatory disclosure language only applies to BNY Mellon and the distribution of this report by BNY Mellon. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation. The statements and opinions expressed in this report do not necessarily represent the views of BNY Mellon or any of its respective affiliates. The information in this report is not intended and should not be construed to be investment advice in any manner or form; its redistribution by BNY Mellon may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where this report is used or distributed in any non-U.S. jurisdiction, the information provided is for use by professional investors only and not for onward distribution to, or to be relied upon by, retail investors. • This report is not intended, and should not be construed, as an offer or solicitation of services or products or an endorsement thereof by BNY Mellon in any jurisdiction or in any circumstance that is otherwise unlawful or unauthorized. BNY Mellon Asset Management International Limited and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. • Past performance is not a guide to future performance. The value of investments and the income from themCover: Shutterstock is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. 11 © The Economist Intelligence Unit Limited 2012
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