02 October 2018

OMFIF: Central banks face 'hot breath' over QE

Political constraints on the US Federal Reserve and the ECB restarting large-scale asset purchases to combat a future recession will be much greater than after the 2008 financial crisis. That was a major conclusion of an OMFIF seminar in New York.

Interest rates are unlikely to rise high enough during the current tightening cycle to quell any coming downturn simply with rate cuts. So there was general recognition that, on both sides of the Atlantic, QE would be part of central banks' future toolkit for dealing with the next economic dip.

Europe's predicament was deemed more vulnerable than that of the US because of the lack of a centralised political and financial entity as a counterparty to the ECB , which one former US economic official said had been the 'unsung hero' of the crisis. 'We are under close scrutiny,' one European official said, lamenting the lack of a broadly attractive universal 'safe asset' in a politically fragmented Europe.

Another European official termed as an 'understatement' that, in the European Union, 'zero political impetus' existed to enhance Europe's combined 'fiscal capacity'. This raised the worrying perspective that the ECB would be asked to do more in any future downturn, but with less political backing than when Mario Draghi, ECB president, declared in 2012 it would do 'whatever it takes' to save the euro. Doubts were expressed whether Draghi's successor, taking over in November 2019, would have the same clout.

Participants from all sides were clear that QE had fulfilled its main function of lowering financial market yields and forestalling a still worse downturn. 'I believed it would work and it did work,' said a former senior Fed official. Large-scale asset purchases had now been used by many 'respectable' central banks. 'It is not revolutionary – does raise activity – and I would do it again.' European officials cautioned that QE was part of a 'comprehensive framework' that included negative interest rates (not used so far in the US and still of doubtful viability in the future) and forward guidance on keeping rates low.

Ben Broadbent, deputy governor for monetary policy at the Bank of England, made a closing lunchtime speech comprehensively rebutting the widespread suggestion, made two years ago by UK Prime Minister Theresa May, that QE had unduly helped wealthier asset owners and increased inequality. Broadbent pointed out that equity and house prices remain in real terms comfortably below pre-crisis levels.

Another official noted that, because of 'intertwined' links with fiscal policy, QE had important implications for central bank independence. There was nervousness about sensitivities in Germany in particular. The burgeoning political debate in Germany over the Bundesbank's much-increased Target-2 claims on the ECB stood in sharp contrast to the position in France, where Target-2 attracted little or no attention, including among senior parliamentarians.

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