Those Crucial Yet Limited Central Banks

by: Cliff Waldman, Chief Economist

For only the second time in a decade and the first time in a year, the Federal Open Market Committee, the policymaking body of the Federal Reserve, has elected to increase the target range for its influential federal funds rate by 25 basis points to 0.50% to 0.75%.
The slowness of action has been remarkable. Technically, the Great Recession bottomed in 2009. The economy has been growing for more than seven years and we still do not even have a 1% policy interest rate. Further, the decision-making process has been excruciating. After the December 2015 hike, I quipped that there was probably less planning and discussion before the Normandy invasion.
To get a full perspective on this odd business, it is necessary to consider the post-crisis global picture and its seemingly unique psychology. For example, we have recently experienced a dramatic decline in the spot price of oil, yet markets, instead of applauding, exhibited anxiety. What’s going on? The true fear that has kept the Fed and other major central banks from normalizing policy and that has created apparently odd market reactions can be summarized in one word—deflation.
At least at a gut level, we all understand inflation. Most of us were taught the basic understanding that prices rise and that such things as household spending and wages need to be adjusted for inflation. But once in a long while, deflation, which is an actual fall in the average price level, becomes a part of economic reality. Deflation, to be blunt about it, is a plague. We need to make sure that we push it back as far as we can. Just ask the Japanese people, who understand full well that it is economically pernicious. It was the underlying force of a long period of Japanese stagnation.
An examination of price data for many parts of the globe gives reason for concern, but not outright panic, about deflation. World prices as a whole are disconcertingly hovering right around the zero line but at the same time there is no evidence of a deflationary spiral. Regardless, the fear that accommodative monetary policy is the only thing standing between the world and economically destructive deflation is the reason for such slow movement on the part of the Fed.
It is indeed the case that the quick actions of the Fed and a few other major central banks prevented the kind of deflationary spiral in 2008 and 2009 that precipitated the tragic economic spiral of the early 1930s. But it is time now for governments around the world to realize the limits of monetary policy and to start attacking the fundamentals of slow growth. This mostly means that they need to make the kind of investments that will accelerate the weak global productivity picture. Monetary policy just can’t do this alone. It’s a powerful but limited tool.
The central banks have done their job. They have prevented the floor from falling under our feet. But if we want to really accelerate growth, other tools are needed to spur investments and thus strengthen long-term performance.