Central Banks Effectiveness?

Central banks are crucial for supporting growth, controlling inflation and stabilizing economies – a duty that is growing increasingly difficult as these institutions become more politicised.

A significant moment for Central Banks was last week when the March Federal Open Market Committee (FOMC) minutes were released, giving us insight into the Federal Reserve's views on the global economy and rate cuts, and the European Central Bank (ECB) decided to remain on its ultra-accommodative path.

Fed rate cuts

From the minutes of the March FOMC meeting, the Fed does not expect to raise rates this year as a result of the global economic slowdown and uncertainty over trade policy. It seems that the Fed is confident that it has acted quickly enough in changing its policy stance, that it does not need to do more any time soon, and that the US economy will be able to endure a global slowdown.

This could be worrying, as the Fed may become satisfied in remaining with this holding pattern – just as it became satisfied about regularly raising rates last year.

The minutes changed market expectations dramatically. As of end of March, a greater than 65 percent probability was assigned to one or more rate cuts by the end of the year. Further on, as of mid-April, that probability fell to 36 percent.

Bank of Canada pause

The Bank of Canada (BOC) clearly has a similar position to that of the Fed. In a recent speech, the BOC’s Governor suggested that the BOC will keep rates below the neutral rate given the headwinds facing the Canadian economy. Headwinds such as trade uncertainty, housing market weakness and higher debt levels for Canadian households.

ECB holding the rope

Last week, the ECB met and decided to leave its ultra-accommodative monetary policy unchanged. The claimed rationale was to give recent monetary policy stimulus time to work its way into the economy. If this is enough is doubtful given the deterioration in economic data that has occurred in recent months. Monetary policy stimulus will be harder to achieve if systemic stress rises in coming months, as geopolitical risks rise given EU elections, Spanish elections and growing debt issues for countries such as Italy.

Draghi did confirm that policymakers were considering measures to mitigate the negative impact on banks of its negative deposit rates and new targeted longer-term refinancing operations (TLTRO) loans to banks, but said it was too early to decide. That being said, if the ECB did do more it is uncertain how markets would have reacted.

Why? It is known that eight of the nineteen central bank governors of the ECB governing council will step down by the end of the year and so markets may not have much confidence in whatever decisions the current ECB makes, assuming the next edition of the ECB may alter course.

Growing tide of politicism

Last week we saw that central banks continue to bear an enormous burden for supporting growth, controlling inflation and stabilizing economies in the face of growing challenges. That responsibility is growing increasingly difficult as central banks become more politicised.

For example, because European elections will be held in May, the selection of Draghi's successor is likely to be more political in nature. Politicisation of central banks, which we have seen in Turkey and India as well as the US, is a significant enough issue that it was a major topic at last week's IMF meeting.

It seems logical that the populist movement would want to take control of central banks. The reality is that central bank policies aggravated wealth inequality in the past decade, helping to pave the way from geopolitical disruption and the rise of populism.

Why is this a concern?

If central banks become more politicised, they may not be able to intervene as effectively in future crises. This could be particularly problematic given that countries may have greater difficulty intervening fiscally in the face of crises given high debt levels. Rise in debt levels are continuing despite many countries experiencing economic expansions, which is typically the time when governments are expected to pay down debt rather than take on more.