As central banks continue to play an increasingly large role in the post-recession economy, driving forward sometimes controversial monetary policies, it’s easy to wonder - what was their purpose in the first place? Have they lost the original plot? Perhaps most importantly, as the world anxiously awaits the May 3 Fed announcement, how did a group of academics come to have so much power over the global economy?
At the 2017 Cayman Alternative Investment Summit (CAIS), expert economists took a critical look at the role of central banks in today’s world and explored some of the key issues that these institutions face going forward. (For more, see: Investing in a Post-Brexit World: Ideas from CAIS 2017.)
The CAIS expert panel included:
- Constance Hunter, Chief Economist at KPMG
- John Mauldin, President of Mauldin Economics
- Nouriel Roubini, CEO of Roubini Macro Associates
- Michael Green, Portfolio manager at Thiel Macro LLC
What is the Goal of a Central Bank?
Before the financial crisis, the role of a central bank was to pursue two goals: price stability and full employment. However, following the recession, we’ve seen an “explosion of central bank goals and policy tools,” said Nouriel Roubini. In today’s world, central banks have become increasingly responsible for the overall health of the economy, concerning themselves not only with prices and employment, but with fiscal policy, public debt, financial regulation, and exchange rates as well. This was exemplified at the European Central Bank (ECB) press conference last week, when ECB President Mario Draghi’s economic analysis touched on trade protectionism, the French election, and the broader impacts of globalization.
And with this expansion of goals has come a whole new set of policy tools. Phrases that were relatively unheard of before 2008 - like quantitative easing, credit easing, zero interest rate policy - have become commonplace in the financial vernacular, reflecting the evolving role of central banks and their expanding powers.
Have Central Banks Lost the Plot?
Our panelists agreed that a major part of the central bank narrative has been the need for inflation. Banks around the world have set inflationary targets and have explored monetary policies in line with this goal. However, CAIS economists disagreed over the effectiveness of this goal and whether central banks are in fact going in the right direction. (For more, see: What Should Investors Expect from Markets in 2017?)
When asked whether central banks have lost the plot, the answer from economist John Mauldin, was a resounding “yes.” He questioned the need for central banks altogether, claiming that while they may be necessary for liquidity reasons, setting interest rates is a market function and an unnecessary responsibility for a small group of academics. He also asserted that central banks wrongly assume they can drive economies by encouraging consumption, when the real focus should be on income and fiscal policies that promote small business.
Though less critical of central banks as a whole, Michael Green agreed that central banks have the story wrong. He argued that central banks shouldn’t be targeting specific levels of inflation like the 2% mark, yet they continue to do so because of the potential debt and social instability issues that come from deflation. Green discussed Japan as an example, which he believes is driving inflation in an attempt to decrease the value of their workers and make themselves more competitive on the global stage - meanwhile damaging their standard of living. Europe is similarly committed to a 2% inflation rate, with Mario Draghi stating last week that the eurozone still needs a “very substantial degree of monetary accommodation” to get inflation back to the 2% level.
Unlike Mauldin and Green, Nouriel Roubini argued that the goal of a central bank should be price stability, and that central banks are on the right track in this regard. He supports a 2% inflation target as a minimum and doesn’t think we should accept that the normal interest rate is zero.
What Are Some Concerns Going Forward?
One of the main concerns raised by the panel going forward was the idea of an oncoming pension crisis in this era of low interest rates. Despite political pressure for pension funds to return over 6% a year, this is incredibly difficult in the current rate environment. Figuring out how to maintain sufficient funds to pay pensions on time will be a critical question for central banks to deal with if we continue to see low rates. Japan has just lowered the amount that people are getting from their pensions in 2017 due to deflation, but it’s questionable whether this approach could work in a country like the United States. (For more, see: When Politics Drives Markets: CAIS 2017 Global Market Outlook.)
For more conference highlights, follow the Cayman Alternative Investment Summit at @CaymanSummit.