With politicians in the U.S. and Europe abrogating responsibility for getting their zones of the world economy growing again, the task falls by default to central bankers. Yet they are standing pat for fear of being left spent in the event the feared second dip of recession materializes.
Economists have been cutting their global and national economic growth forecasts in recent months, but leading central banks have taken only relatively modest steps to stimulate economies. To deploy a cliche, they may have been talking the talk. They are not walking the walk. This week:
- the ECB left its benchmark interest rate unchanged at 0.75%. Last week, its president, Mario Draghi, promised to do “whatever it takes” to preserve the euro;
- the Bank of England, which last month announced an increase of £50 billion ($78 billion) in its quantitative easing (QE) program, held its benchmark interest rate at 0.5%;
- The U.S. Federal Reserve confirmed that it would keep keep its extremely low interest rates (0.0-0.25%) until late 2014.
Meanwhile, in the world of factory floors and customers, the JP Morgan Global Manufacturing Purchasing Managers’ Index (PMI) fell to 48.4 in July from 49.1 in June–edging even further away from the dividing line of 50 that separates contraction from expansion. Like central bankers in China, those in Europe and the U.S. are holding out the hope that the policy actions they have already taken will kick-in in time. That they are now keeping the last of their policy powder dry suggests that they are hoping against all hope.
Mario Draghi’s reputation as an inflation hawk took a back seat to his other reputation for being his own man when at his first meeting as head of the European Central Bank he surprised markets by cutting the central bank’s benchmark interest rate by a quarter of a percentage point to 1.25%. It would be too harsh to represent this as a slap in the face of his predecessor, Jean-Claude Trichet, who was criticized for raising rates, in the German interest, as it was taken to be, during a time of credit crisis, but Draghi’s reversal is a welcome sign of what will be a continuing need for independence especially in the face of the euro-zone leadership’s continuing inability to get a grip on its debt crisis. His diplomatic skills can mask the extent to which he is self-confident about following his chosen course, but as Europe politicians may find, being Jesuit-educated, Draghi will know how to make their minds follow.
In the card game 21s, a player can ‘twist’ to get another card from the dealer in the hope of reaching an aggregate face value of his hand of exactly 21. More often it is done in hope rather than expectation. So with the U.S. Federal Reserve’s latest attempt at stimulating the U.S. economy, Operation Twist. Banish the thought that this could be called QE3. After all, the Fed’s second round of quantitative easing did not achieve much in the way of generating additional demand to get the U.S. economy growing at anything but the most sluggish pace. It faces the same uphill battle with Operation Twist, intended to nudge down long-term interest rates as QE2 was intended to push down short-term ones. (Historic footnote: when the Fed tried the same tactic in 1961 it was originally called Operation Nudge)
Operation Twist will work like this: Between now and the end of June next year, the Fed will buy $400 billion dollars in Treasury bonds with maturities of 6-30 years. It will finance these purchases by selling an equal amount of debt with maturity of 3 years or less. In this way it will lengthen the average maturity of its debt holdings but does not need to expand its balance sheet to do so. Creating demand for longer-term bonds should drive down their yield.
Yet the U.S. economy already has very low interest rates by historic standards, and has, by now, had them for some time. It is not the cost of credit that is the issue but the demand for it. Large companies are awash with cash. They have neither the need to borrow, however cheaply, nor, more importantly, for as long as they see no increase in final demand for their goods and services, the appetite to invest that would require borrowings. Similarly with individuals. Mortgages, which are tied to long-term interest rates, are already cheap, for those who can get them, or want them. The housing market in the U.S. is not only battered but frozen. The lack of consumer confidence under the long dark shadow of persistent high unemployment is keeping it so. So neither companies nor individuals are prepared to commit the spending needed for a sounder recovery. Easier monetary conditions won’t make any significant impact on that.