Daddy isn’t superman: Accepting the limits of easing
Somewhere on this blue earth, there is probably a tear-stained drawing of Ben Bernanke in billowing red cape and blue spandex suit with the acronym ‘QE’ emblazoned on his powerful chest.
Those tears were likely shed sometime late this year, perhaps by some young and ambitious economist at the European Central Bank.
It’s said that many sons grow up thinking their fathers are supermen, and that the realization that they are bound by human limits is an important, sometimes painful step towards growth.
One of the starkest developments of the last year in financial markets has been the growing realization of the limitations of central banks. Since the crisis, four of the most powerful central banks in the world have all embarked on formidable and prolonged programmes of monetary easing, including quantitative easing in the US, UK and Japan.
And while this last round of QE may have indeed helped pull the US out of dumps, the programme worked in part because the US acted quickly (and first), with QE1 in 2008. It also acted in the enormous Treasury and mortgage-backed securities markets.
But markets — and central bankers — seem to be getting around to the realization that central banks aren’t all powerful, and that they don’t act in a vacuum. What works at one time in one market won’t necessarily work at a different time in a different market.
Nowhere is that realization more apparent than in the evolution of ECB president Mario Draghi’s own remarks on the topic. Beginning with his statement in 2012 that the central bank would do “whatever it takes” to save the euro, the European capital markets have swooned to nearly every comment he’s made on the ECB’s power and intent to keep the euro together and stimulate the eurozone recovery.
But his statements this year, most recently that the ECB will “do what we must” to raise inflation and inflation expectations, share more in common with “whatever we can” than “whatever it takes”. Essentially, it is an admission that the ECB can’t fight this fight alone.
He’s forthrightly made this same point himself, warning that structural reforms are badly needed to effect a healthier recovery and avoid potential deflation.
And it appears market participants are beginning to agree. Some have outspokenly derided the ECB’s plans to buy covered bonds, asset-backed securities and its sabre-rattling over buying corporates and sovereign debt. Fears of asset bubbles have become more intense, and more are calling for structural reforms and increased public investment.
Repeatedly disappointing numbers out of Japan are also hacking away at confidence in Abenomics — whose crucial ‘third arrow’ of structural reform was widely considered to have underwhelmed.
It’s time to give up the notion that easing is everything. The eurozone could be looking at its own ‘lost decade’ if a different approach is not taken soon. Policymakers need to acknowledge that the ECB’s powers are limited. The European Investment Bank’s €300bn investment plan is a good start. Structural reforms are the next step. Painful and politically difficult as they may be, this will likely be the European Union’s biggest and most important challenge in years to come.