Fair warning, this is going to be a wonky post. (If you’re unsure what asset purchases or quantitative easing is and you’re wondering why in the world i keep talking about it, see this explainer.)
This week was a big one for acronyms. The Fed’s Federal Open Market Committee (FOMC) and the Bank of England’s Monetary Policy Committee (MPC) met on November 5th. The Reserve Bank’s Board (surprisingly no one calls it the RBB) met two days earlier on November 3rd. These are the respective committees at each central bank that make decisions on policy like interest rates or quantitative easing.
Bank of England
The BoE kept interest rates at 0.1% and added an additional £150 billion in government bond purchases, taking the total stock to £875 billion. In their words:
The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.
The BoE predicts inflation will be back at 2% in two years time. Given the potted history of central bank inflation predictions, this should be taken with a grain of salt. Still, policy looks set to stay incredibly accommodative for at least two years.
Reserve Bank of Australia
The cash rate was lowered to 0.1% and $100 billion in new government bond purchases was announced. The RBA is also one of the few central banks in the world to do Yield Curve Control (YCC), where they commit to keeping the yield on a certain category of bond (in this case a 3-year Australian Government) at a certain rate. It is an open-ended commitment to buy any quantity of bonds required to achieve the target rate, which is 0.1%. In simple terms, the Australian Government can take out three year loans at 0.1% as long as the RBA keeps this policy in place. How long will policy stay like this?
For its part, the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. Given the outlook, the Board is not expecting to increase the cash rate for at least three years. The Board will keep the size of the bond purchase program under review, particularly in light of the evolving outlook for jobs and inflation. The Board is prepared to do more if necessary.
Its important to note that while the cash rate is staying where it is for at least three years, the RBA might wind back its bond purchases or YCC. Either way its an incredible commitment, especially given inflation has been so subdued globally for the last decade.
The Fed switched to average inflation targeting this year. Instead of just apologizing for missing their inflation target, the Fed will now attempt to average out past inflation performance. Put simply, if the target is 2% and inflation averaged 1% between 2010-2020, then inflation needs to average 3% between 2020-2030. It is a little more complicated because the Fed has not been explicit about what periods they will use, how they will calculate the average, or how high they will let it go, but that’s the basic premise. Here’s the relevant part of the statement:
With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.
The Fed kept interest rates where they were, 0-0.25%, and will continue to purchase bonds at the current pace of $120 billion a month.
Chairman Powell continues to emphasise minorities and low-income groups:
The economic downturn has not fallen equally on all Americans, and those
least able to shoulder the burden have been hardest hit. In particular, the high level of joblessness has been especially severe for lower-wage workers in the services sector, for women, and for African Americans and Hispanics
Powell’s appeals for more fiscal stimulus come at a time when the prospect of a Republican Senate and Democrat President make new stimulus increasingly fraught:
As I have emphasized before, these are lending powers, not spending powers. The Fed cannot grant money to particular beneficiaries. We can only create programs or facilities with broad-based eligibility to make loans to solvent entities with the expectation that the loans will be repaid. Many borrowers are benefiting from these programs, as is the overall economy. But for many others, getting a loan that may be difficult to repay may not be the answer. In these cases, direct fiscal support may be needed. Elected officials have the power to tax and spend and to make decisions about where we, as a society, should direct our collective resources
Monetary policy looks set to be incredibly accommodative for at least two more years, possibly longer should inflation continue to be stubborn. What are the implications?
- Financial stability risks: The longer monetary policy is accommodative, the greater the financial stability risks. This is no secret and banks have macroprudential policy (MPP) tools at their disposal. Still, MPP is a newish field and there are still questions about the best approach.
- Will monetary policy continue to crowd out fiscal policy? Over the last five years or so, central banks have become increasingly vocal about the need for fiscal stimulus. Covid-19 finally forced open the purse strings, but its an open question how long it will last. Before the second wave, the UK Chancellor was already talking about debt, and the austerity hawks are never far from the opinion pages of the Australian or the Washington Post. Will the commitment of three years of super expansionary monetary policy make it easier for governments to take their foot off the gas?
There is no easy solution to this problem, in part because its the result of the system working as intended. Independent central banks were partly set up as a check on fiscal policy, and to take as much discretionary macroeconomic policy out of the hands of elected politicians as possible. We are now in the awkward position where the politicians have learnt the lesson too well, and are happy to hand off macroeconomic management to central banks.
- No one knows what monetary policy normalization will look like: The Fed’s asset portfolio is north of $5 trillion, the ECB’s €3 trillion, the BoE almost £1 trillion. Japan is another universe; the Bank of Japan’s portfolio is bigger than Japan’s GDP. (The chart below is pre-Covid, so the numbers are actually significantly higher – the Fed has added almost a trillion in asset purchases this year.)
The point is that these numbers are so large they are probably impossible to eliminate, especially because central banks have been clear that QE is now a standard part of counter-cyclical policy. To date it looks as if central banks holding nearly 50% of their government’s outstanding debt is fine? In fact central banks regularly insist these holdings are “market neutral.” The point is, we’re in a Wild West where the only thing we know is that the limits of the past were figments of our collective imagination or a world that now lives only in history books. This is good news for progressives.