Central banks face ‘hot breath’ over QE

US, Europe both under pressure on asset purchases

Political constraints on the US Federal Reserve and the European Central Bank 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 on 28 September linking past and present policy-makers from the US and Europe discussing 10 years of quantitative easing after the Lehman Brothers bankruptcy in September 2008.

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.

The seminar, supported by The OMFIF Foundation, was attended by around 50 public and private sector participants.

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.

The seminar heard general disquiet about continuing German constitutional court challenges to the ECB’s QE policy, the rise of anti-euro political parties across the continent, and the weakening of German Chancellor Angela Merkel. European officials voiced concern about the eurosceptic Rome government’s pre-seminar announcement of a higher-than-agreed budget deficit of 2.4% of GDP for the next three years.

Internationally, central banks faced a far greater need for political accountability. In America, ‘the realities of political economy are now more binding than before the financial crisis,’ according to one US participant. Suggesting the ‘hot breath’ of politicians was now ‘on central bankers’ shoulders’, he added that leeway for purely technocratic solutions was constrained. ‘How does the House financial services committee react when you tell them you need a $50bn cheque?’

On the other hand, despite President Donald Trump’s ‘financial excesses’, the US was favoured by general demand for the dollar. ‘The US is issuing debt as far as the eye can see – but there’s a lot of demand for these safe assets… The rest of the world is ready to buy [them].’

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 former US official said QE lowered return for savers and this influenced distribution of income. ‘But it saved us from a repeat of the 1930s – I don’t recall that was a time when everyone was linking arms and saying how good it was to have quality income.’ The Fed’s ‘quantitative tightening’ now under way with gradual shrinkage of its balance sheet through asset disposal, would have only a modest restrictive effect compared with $1.5tn of tax cuts and a similar volume of spending increases in coming years by the Trump administration, this participant said.

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.

David Marsh is Chairman at OMFIF.

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