Monetary easing looks different this time around

As the global economy slows, central bank policies won’t follow the same path as a decade ago.

  • By Brian Blackstone,
  • The Wall Street Journal
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Central banks around the world are responding in different ways to current economic challenges. Some have shifted from modest tightening to pauses. A few have cut rates.

With the global economy slowing and inflation falling below targets set by many banks, economists and investors are pondering what the next easing cycle will look like. One thing seems certain: It won’t look like the last one.

When the financial crisis escalated one decade ago, developed-country central banks in the West lowered interest rates aggressively, including a coordinated move in 2008. But now, smaller central banks in the Asia-Pacific region and Southern Asia appear to be leading the way. Since April, New Zealand, India, Malaysia and the Philippines all have lowered rates.

Australia’s central bank lowered its policy rate on June 4, making it the biggest developed-country central bank to reduce rates in 2019. U.S. Federal Reserve officials have signaled that they could follow suit in the next few months.

Still, policy choices for many wealthy, but also slowing, economies in the West are constrained by low and in many cases negative interest rates. Faced with the unappetizing prospect of pushing rates further into negative territory, some central banks in the West may choose to quickly dip into their unconventional toolboxes with asset purchases.

“Central banks will be able to activate their economies somehow through monetary policy, but they’re starting from a very low base,” says Arturo Bris, professor at IMD in Lausanne, Switzerland.

If economies around the world only encounter a soft patch with slow growth and inflation in the 1% to 1.5% range, then policy makers everywhere can probably respond with a mix of limited rate reductions and commitments to keep monetary policy loose for an extended period.

That still seems the likeliest scenario. The U.S. economy grew more than 3% annualized last quarter, and the eurozone grew 1.6%, led by Germany, easing fears of a recession in Europe. China’s economy has slowed, but the People’s Bank of China has taken steps to boost lending.

If global growth stalls, however, and key economies enter recession, things could get tricky. Central bankers then may soon confront the limits of what they can do with their depleted tool kits. And trouble spots linger that could trigger just such an outcome, such as the U.S.-China trade war, and the buildup of corporate debt and rising prices for homes and other assets in some rich countries—potential bubbles that could cause destabilizing ripples if they burst.

“If it’s a run-of-the-mill, cyclical downturn where growth dips below potential, then most central banks outside Europe and Japan have enough conventional tools to combat that,” says Neil Shearing, chief economist at Capital Economics in London. “The big question is what happens if there’s a big shock. There you get quite quickly to the limits of monetary policy.”

In that case, whatever mix of measures the world’s central banks unload to combat the next recession, it may not be enough. And any eventual downturn could worsen if investors grow concerned that the most powerful guardians of the global economy, central banks, are unable to turn things around.

China’s central bank announced May 6 that it would lower the reserve-requirement ratio for the nation’s small and medium-size banks, releasing about 280 billion yuan ($40 billion) liquidity to encourage more bank lending to private small businesses. The easing move was also seen as a sign that Beijing tried to shore up market sentiment amid renewed trade tensions with the U.S.

Economists widely believe that China’s central bank will further lower its reserve ratio this year and urge banks to provide more credit to small businesses. Some economists even have predicted that the central bank may cut open-market interest rates to reduce financing costs for lenders.

“China has the ability to ease more, as much as needed,” says Roberto Perli, economist at Cornerstone Macro in Washington, D.C. “If that happens, I don’t think that Europe is going to go into recession, or the U.S. or Japan.”

Still, financial markets increasingly see the Fed joining within months those central banks that have eased. St. Louis Fed President James Bullard said on June 3 that a rate cut “may be warranted soon.” The federal-funds rate has been between 2.25% and 2.5% since the rate increase in December. Mr. Shearing expects one quarter-percentage-point rate cut this year and two more in 2020.

“We need to prepare ourselves for bad times coming,” says Prof. Bris. “The Federal Reserve is much better prepared than others,” he adds, because it already has been raising interest rates, giving it room to ease when necessary.

But were a recession to loom that raises unemployment and brings inflation toward zero, even the Fed could run out of conventional ammunition quickly. It shaved rates by more than 5 percentage points in a little over a year from 2007 to late 2008. It cut rates by a similar amount from 2001 to 2003 after the tech bubble burst, even though that recession was milder than the one during the financial crisis. It now has less than half that much room in which to start lowering rates before it hits negative-rate territory.

Central banks in Europe are in the trickiest spot, with policy rates below zero in the vast majority of the region, including the eurozone, Sweden, Switzerland and Denmark. Cutting rates more in those regions wouldn’t do much to stimulate their economies and could further weaken the commercial banks that must pay those negative rates to their central banks.

Some members of the European Central Bank’s rate council discussed lowering rates or restarting bond purchases at their June 6 meeting, ECB President Mario Draghi said after the meeting. The deposit rate has been at minus 0.4% since 2016, and the ECB only recently ended net bond purchases under its quantitative-easing program, which it started years after the Fed did. But restarting it might not help much, and would prove controversial in Germany.

Had the bank taken more aggressive steps sooner in the aftermath of the global financial crisis and during Europe’s ensuing debt crisis, it might have been in better position to ease policy now, economists say.

“It’s ironic that [the ECB] got trapped into this loose policy because they didn’t do enough loosening to start off with,” says Mr. Shearing.

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