11/11/2013 (Mareeg.com) NEWPORT BEACH – History is full of people and institutions that rose to positions of
supremacy only to come crashing down. In most cases, hubris – a sense of
invincibility fed by uncontested power – was their undoing. In other cases, however,
both the rise and the fall stemmed more from the unwarranted expectations of those
around them.
Over the last few years, the central banks of the largest advanced economies have
assumed a quasi-dominant policymaking position. In 2008, they were called upon to
fix financial-market dysfunction before it tipped the world into Great Depression
II. In the five years since then, they have taken on greater responsibility for
delivering a growing list of economic and financial outcomes.
The more responsibilities central banks have acquired, the greater the expectations
for what they can achieve, especially with regard to the much-sought-after trifecta
of greater financial stability, faster economic growth, and more buoyant job
creation. And governments that once resented central banks’ power are now happy to
have them compensate for their own economic-governance shortfalls – so much so that
some legislatures seem to feel empowered to lapse repeatedly into irresponsible
behavior.
Advanced-country central banks never aspired to their current position; they got
there because, at every stage, the alternatives seemed to imply a worse outcome for
society. Indeed, central banks’ assumption of additional responsibilities has been
motivated less by a desire for greater power than by a sense of moral obligation,
and most central bankers are only reluctantly embracing their new role and
visibility.
With other policymaking entities sidelined by an unusual degree of domestic and
regional political polarization, advanced-country central banks felt obliged to act
on their greater operational autonomy and relative political independence. At every
stage, their hope was to buy time for other policymakers to get their act together,
only to find themselves forced to look for ways to buy even more time.
Central banks were among the first to warn that their ability to compensate for
others’ inaction is neither endless nor risk-free. They acknowledged early on that
they were using imperfect and untested tools. And they have repeatedly cautioned
that the longer they remain in their current position, the greater the risk that
their good work will be associated with mounting collateral damage and unintended
consequences.
The trouble is that few outsiders seem to be listening, much less preparing to
confront the eventual limits of central-bank effectiveness. As a result, they risk
aggravating the potential challenges.
This is particularly true of those policymaking entities that possess much better
tools for addressing advanced economies’ growth and employment problems. Rather than
use the opportunity provided by central banks’ unconventional monetary policies to
respond effectively, too many of them have slipped into an essentially dormant mode
of inaction and denial.
In the United States, for the fifth year in a row, Congress has yet to pass a
full-fledged budget, let alone dealt with the economy’s growth and employment
headwinds. In the eurozone, fiscal integration and pro-growth regional initiatives
have essentially stalled, as have banking initiatives that are outside the direct
purview of the European Central Bank. Even Japan is a question mark, though it was a
change of government that pushed the central bank to exceed (in relative terms) the
Federal Reserve’s own unconventional balance-sheet operations.
Markets, too, have fallen into a state of relative complacency.
Comforted by the notion of a “central-bank put,” many investors have been willing to
“look through” countries’ unbalanced economic policies, as well as the severe
political polarization that now prevails in some of them. The result is financial
risk-taking that exceeds what would be warranted strictly by underlying fundamentals
– a phenomenon that has been turbocharged by the short-term nature of incentive
structures and the lucrative market opportunities afforded until now by central
banks’ assurance of generous liquidity conditions.
By contrast, non-financial companies seem to take a more nuanced approach to central
banks’ role. Central banks’ mystique, enigmatic policy instruments, and virtually
unconstrained access to the printing press undoubtedly captivate some. Others,
particularly large corporates, appear more skeptical. Doubting the multi-year
sustainability of current economic policy, they are holding back on long-term
investments and, instead, opting for higher self-insurance.
Of course, all problems would quickly disappear if central banks were to succeed in
delivering a durable economic recovery: sustained rapid growth, strong job creation,
stable financial conditions, and more inclusive prosperity. But central banks cannot
do it alone. Their inevitably imperfect measures need to be supplemented by more
timely and comprehensive responses by other policymaking entities – and that, in
turn, requires much more constructive national, regional, and global political
paradigms.
Having been pushed into an abnormal position of policy supremacy, central banks –
and those who have become dependent on their ultra-activist policymaking – would be
well advised to consider what may lie ahead and what to do now to minimize related
risks. Based on current trends, central banks’ reputation increasingly will be in
the hands of outsiders – feuding politicians, other (less-responsive) policymaking
entities, and markets that have over-estimated the monetary authorities’ power.
Pushed into an unenviable position, advanced-country central banks are risking more
than their standing in society. They are also putting on the line their political
independence and the hard-won credibility needed to influence private-sector
behavior. It is in no one’s interest to see these critical institutions come
crashing down.
Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and the author of When Markets
Collide.
Project Syndicate, 2013.
