Vanguard experts discuss the limitations of central bank policies

Key central banks in developed markets have adopted ultra-low interest rates in the hopes of stimulating economic growth. Chief Economist for the Americas Roger Aliaga-Díaz, Economist Alexis Gray, and Senior Economic Strategist Andrew Patterson examine why many of these central banks have had difficulty achieving their growth and inflation targets.

Also of interest:
Vanguard Perspectives® Noni Robinson: In most developed markets, interest rates are near or below zero yet inflation rates are still below target. What, if anything, can central banks do to boost their economies?

Alexis Gray: It’s certainly true that central banks are running into a dilemma. It’s now been eight years, I think, that we’ve had interest rates at or below zero across developed markets and we still have inflation below target, particularly in the euro area and in Japan, where they’re in outright deflation now. And we’re starting to see central banks trying to think even further out. If you think of the unconventional policies we’ve already had—negative interest rates, quantitative easing, the Bank of Japan talking about overshooting their inflation target—we never saw these types of policies before the global financial crisis. So they’ve got their creative thinking hats on right now of what more they can do. And I think there’s also been criticism from outside that perhaps this problem of low inflation can’t even be solved by central banks. So there’s talk of maybe bringing in fiscal policy or structural reforms from governments, but it’s certainly a time where I think central banks are reflecting on: What is their role? And what more can they do from here?

Roger Aliaga-Díaz: In theory, there are no limits on how creative they can be, as we probably have been seeing for a while. There are conversations of things like helicopter money, which is effectively monetary financing of the debt and things like that. But what is really starting to become a little bit of a concern is not only that effects are not there, not only that we are not seeing inflation pick up but, also, if there are other unintended consequences of this policy, dislocations in the financial markets. When we think what happened to interest rates this year, for example in the U.S., with the U.S. economy faring fairly well in terms of economic growth—still, rates going another few basis points down. That basically starts giving some indications that there could be some dislocations, some unintended consequences medium term of this rate environment, not only [in the] U.S. but mostly from the global front.

Andrew Patterson: In general, there’s been an overreliance on monetary policy and an inflation of its capabilities since the onset of the global financial crisis. [Former Federal Reserve Chairman] Ben Bernanke was very vocal in the idea that monetary policy has limits, [European Central Bank President] Mario Draghi echoed those statements, and [Fed Chair] Janet Yellen herself has called on other policymakers, be they fiscal policymakers, be it changes in structural policy—on the need for those to try to pick up some of the slack. Not a complete handoff of the baton. We’re not going to see any type of abrupt tightening of monetary policy, but more sharing the wealth, so to speak, so that we can try to get a foothold not only on the central banks’ stated objectives, typically, inflation in the U.S., the labor market, but also on global growth, right? That’s really what people are clamoring for. And at the end of the day, monetary policy can’t be relied on as the sole driver of growth in any environment.

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