Daily Management Review

Fewer Options Available To Central Bankers To Respond To Next Recession


The central banks of the world might not have the resources to fight a serious recession. 
During the last financial crisis, dramatic and unorthodox steps were taken by the central banks to prevent economic collapse. The measures included slashing of interest rates and expended trillions on bonds in the consequent years as a part of their efforts to stimulate the economies after recession and induce growth.
But now the most important of the global central banks are now reversing those polices and measures a decade later.
Still most of the developed economies have very low rates of interest and they are in the negative n some countries. Some of the bonds it bought are being unloaded by the US Federal Reserve. However that has not so far been done by central banks in Europe and Japan. The question that economists are putting forward is whether the central banks have carried on with their very low and sometimes negative rates of interest for too long and consequently are not in a position to fight off a fresh financial crisis.
"If we have a recession, I think it's going to be worse than normal," said Kenneth Rogoff, a professor at Harvard University and former chief economist at the International Monetary Fund. "It will be more difficult to respond."
Central banks are also being impeded by politics. While threats of political interference have been faced by central banks in countries like India and Turkey, the US Fed has been repeatedly criticised by the US president Donald Trump.
Additionally, the forecast for the growth of the global economy has come down amidst rising trade tensions and trade wars which have resulted in slowdown in the growth of large economies such as China and Germany.
The global growth forecast for 2019 have been reduced by the International Monetary Fund and the World Bank and there are apprehensions that there would be more issues with the rising interest rates in the US, the ongoing trade war and conflicts and the possible impact of Brexit.
While none anticipated that there would be continued synchronous global growth for ever, many believe that the capacity of the central banks to respond to a sharp slowdown now has been diminished by their actions over the past 10 years.
"Think of a car travelling on a bumpy road with no spare tires. You really don't want to have another blown tire," said Mohamed El-Erian, the chief economic adviser at Allianz (AZSEY).
The US fed is in a somewhat better position to ward off an impending financial crisis because the central bank has raised interest rates in the US four times during 2018, El-Erian said. However, currently set between 2.25% and 2.5%, the benchmark rate is still at historic low, that limits its options to bring down rates to spur growth in case there is a financial crisis. "Even the Fed has less flexibility than in the past," he said.
The position, in terms of benchmark interest rates, is worse for European Central Bank and the Bank of Japan. The key lending rate of the ECB is 0 per cent while its rate of interest against deposit is -0.4 per cent. And since 2016, the short-term rates have been in negative territory in Japan.
"They're very limited in what they can do," Rogoff said.