Monetary policy could run out of steam

A simpler monetary policy seems to be the strategy of the day, but the events of the past week have raised questions about its wisdom, its likely effectiveness and even its purpose.

Indeed, as monetary policy is likely to experience diminishing returns, the time has probably come for fiscal policy to bear more stress.

The big central banks are clearly moving towards a new era of cheaper money if we hear the message from the European Central Bank last week. Thursday 's ECB monetary policy meeting laid the groundwork for a comprehensive package of easing measures in September, focused not only on lower key rates, but also on purchases from banks. additional badets and a review of the inflation target and forecast forecasts of the central bank.

While the ECB is doing everything it can to boost inflation, it is becoming increasingly apparent that monetary policy risks losing its effectiveness, all the more so. more than the interest rates in the euro area are already negative.

Tim Fox

However, it was clear from the decision that not all members of the ECB Council were in agreement with the promised measures. President Mario Draghi said that "most members" of the board of governors "converged on this" response to the economic downturn, but acknowledged that the statement did not receive unanimous support.

Thus, while the ECB is using "doing all that is necessary" to stimulate inflation, it is becoming increasingly clear that monetary policy may be losing its effectiveness 39 as much as interest rates in the euro area are already negative. Comparisons with the lost decade of the Bank of Japan's zero rate in the 1990s are increasingly being made. Negative interest rates have an impact on the banking sector's core business of creating spreads on loans and deposits; so it is not surprising to see most banks in the current season of earnings warn of declining net interest margins.

Although the ECB appears to want to continue lowering rates and quantitative easing (QE), its statement also confirmed that it is looking at ways to mitigate the impact of negative interest rates on banks, including the option of a tiered deposit rate. However, this could be another source of tension within the board, with some countries apparently in favor of such an approach and others against.

The same is true for any QE takeover as the central bank's own guidelines on issuer limits leave little room for further government bond purchases. As a result, potential proposals could include an expansion of badet clbades to include equities, but also a change in the voting rights of national central banks to circumvent the limits imposed on issuers. All this could lead to new legal challenges and test the ECB's mandate, even though it seems likely that Mr Draghi will still receive sufficient support for a first set of measures.

The situation of the ECB is of course relatively unique compared to the US Federal Reserve and the Bank of England, both of which managed to raise interest rates after the financial crisis, which allowed them to get into a new wave of monetary easing. However, the data released last week by the United States seems to ask a different question about the effectiveness of interest rate reduction, namely for what purpose.

The slowdown in US gross domestic product growth from 3.1% in the first quarter to 2.1% in the second quarter of 2019 was likely sufficient for the Fed to implement its much-needed 25 basis point federal funding this week. it did not reveal an economy needing much more stimulants than that. This could normally be considered good news for US policymakers, but it is unlikely to be enough for President Donald Trump, who will likely persist in putting pressure on the Fed for it to continue reducing it, placing and Fed Chairman Jerome Powell in an increasingly difficult position. Mr. Powell may think that the Fed has a dual, reasonable mandate: stable prices and maximum sustainable employment, but Mr. Trump seems to have other goals centered on the fact that the Fed has more than just one. to be re-elected in 2020.

Among the leading countries, perhaps it is the UK, led by new Prime Minister Boris Johnson, which is leading the way in preparing a relaxation of fiscal policy. While this may have the specific objective of mitigating the impact of a Brexit without a transaction on the economy, another benefit, if it manages to promote growth, could be to make difficult decisions on monetary policy unnecessary, to which European and American policymakers will think.

Tim Fox is Chief Economist and Head of Research at Emirates NBD