Satyajit Das on Central Banks: Loose Lips Sink Economies
Some recent statements from central bankers risk destabilizing a very fragile financial system.
US Federal Reserve Chairman Ben Bernanke has introduced the term "taper" to the lexicon of central banking. European Central Bank President Mario Draghi's stated strategy is "whatever it takes." Economic Commissioner Olli Rehn recently clarified that European policies were directed at "diluting" not "breaking" the link between banks and sovereigns.
But the statements by the Fed Chairman were hardly surprising. The Fed's unprecedented monetary expansion was always temporary. Confirmation that the measures would continue would admit to failure of policies designed to create a self-sustaining economic and financial recovery. The Fed Chairman also has to manage constituencies within the Federal Reserve uncomfortable with the increased role of the US central bank and foreign nations concerned about the impact of US policies on their currencies and economies. Like ECB President Draghi facing an existential crisis of the euro, Chairman Bernanke, in reality, had little choice.
On one hand, Chairman Bernanke may have been careless and loose in his language. On the other hand, he was deliberating testing the market reaction to the eventual end of central bank support.
Spoken about in the past tense by the US president, Ben Bernanke may also not actually be the Chairman of the Fed at the relevant decision time.
Also, nothing has actually happened. Chairman Bernanke has not halted purchases of Treasury bonds nor increased interest rates.
Despite the confusion about meaning, the statements had a significant impact on prices and rates, leading to large real changes in wealth. "Taper" lived up to at least one of its meanings: a long wick for use in lighting a fire.
With bond and equity markets increasingly volatile, Fed officials have sought to calm unsettled markets, suggesting that the message has been "misinterpreted" or "misunderstood," causing financial markets to be "quite out of synch" with policy. Recognizing the global economy's monetary morphine addiction and also the difficulty of reversing policy, the US central bank officials have even suggested that existing measures could be continued or even increased if necessary. ECB President Draghi and the Governor of the Bank of England have provided guidance that the regime of low interest rates is likely to remain in place for some time.
The reliance on guidance and actual actions of policymakers is troubling:
First, it highlights the fragility of global economies and the financial system, which are now extremely reliant on government support.
Second, the need to "jawbone" exposes the lack of potency of policy tools, which in some cases may be approaching their limits of effectiveness or creating unintended toxic side effects, such as asset price bubbles.
Third, it illustrates the difficulty of international policy coordination. The Fed announcement coincided with a decision by the Chinese central bank to tighten liquidity, exacerbating the market reaction. Given different domestic agendas, the risk of individual action becoming destabilizing is high.
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