Vanguard’s chief economist shares his views on global monetary policy

The U.S. continues its economic recovery while central banks overseas still implement stimulus measures. How big is the gap between U.S. and foreign monetary policies and what does it mean for investors? Joe Davis, Vanguard Global Chief Economist, explains why policy “divergence” is perhaps a misnomer and gives some context to economic conditions around the globe.

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Vanguard Perspectives® Noni Robinson: We’ve been hearing about a divergence in monetary policy around the world with the U.S. experiencing some growth and increase in rate hikes, while other economies are still focused on further easing. What’s Vanguard’s view on all this?

Joe Davis: Well, I’d say broadly, this notion of policy divergence, Noni, in our opinion, is it’s just a misnomer. Clearly, the U.S.—and this was in our view going back for more than a year—the U.S. was going to be, and likely continue to be, the only major central bank to be raising rates. We would have included the U.K., but clearly, with the recent events of Brexit, that’s off the table. But I think there’s a lot of hand-wringing in the sense that the U.S., the Federal Reserve, may be raising rates, [while] the ECB and the Bank of Japan [are] in negative territory and potentially pressed to go further, that that’s somehow both profound and extremely distortionary going forward. I’d say, when we’ve taken a step back and we’ve looked at it historically, first of all, there’ve been much more marked differences between where the U.S. short-term interest rate is and [the interest rates] of Europe and Japan, [the difference was] much more in the past than it is today. I actually think what’s profound is that everyone is close to zero, at or below, or slightly above zero. That’s profound. So if anything, there’s been a convergence in monetary policy, which I think speaks to the global conditions we’re in, with still some deflationary bias in the world from China, and growth that on a cyclical basis still could be a little bit stronger in some areas of the world. So it’s that context and when we hear “divergence”, we say, “Well, divergence with respect to what? Relative to history, where the average difference has been 300 or 400 basis points, today, they’re actually trivial. I think the profound moment in history, that we sit in, is actually convergence in central bank policy. I would also argue that I think central bank is increasingly at its limits. If policy makers, by and large, want to have a greater cyclical thrust on the economy, I think central banks have earned the right, to kind of push back to their fellow policy-making peers and start thinking about fiscal policy with respect to either infrastructure spending or, more importantly, for every major economy, I think there’s some structural reforms that may not show up in the GDP numbers for this year but could very well have a longer-term boost to various economies around the world. So, I think we’re going to hear more of that because I’m personally of the view that negative interest rates are a mistake. And I think that history will show that with the lack of any sort of strong boost of economic growth.  But all this is in the context that this notion of divergence, in our mind, is a misnomer and it’s really [more a] convergence toward zero. And what’s next? I think we will need to see potentially paring of other levers from policy makers writ large if we’re going to see a stronger growth at the margin.

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