Global Central Banks Put Monetary Policy Normalisation Plans On The Table


J.L. M. Campuzano (Spanish Banking Association) | For the first time in many years, global economic growth is surprising both because of its intensity and for the fact it is generalised…

And saving any unforeseen circumstances, it also appears it will be sustained growth. The recovery in productive investment is speeding up, and the annual rate could exceed 3.5% this year. A year ago, growth in this area was 1.5%. An acceleration in investment which is noticeable both in construction and non-construction activity.

So what is supporting this recovery in investment? There is more to it than just overcoming fears of a major slowdown in China and the crises in the emerging economies due to the drop in the price of raw materials. What is undoubtedly making a postive contribution are favourable financing conditions, the reduction in the slack in capacity (including jobs with salary increases which are still contained) and the improvement itself in the potential growth prospects. Let’s remember that the average unemployment rate of 5.7% in the developed economies is the lowest since 2008.

How is all this incorporated into monetary policy design? On Wednesday, the Fed put its strategy for reducing its balance sheet on the table. At the same time, the more bullish message from the US central bank’s meeting has led the market to put more than a 65% probability on there being a new rate hike in December.

Something similar happened at the BoE’s last meeting, where the majority of the board considered it likely that stimuli would be withdrawn in the short-term. And everything points to October as the probable timing for the ECB to move ahead with its balance sheet reduction strategy.

That said, the central banks also recognise that inflation risks are contained in the short-term. That means they have a margin of time to proceed with monetary normalisation in a cautious and patient way. The outlook for inflation in the developed countries remains contained, with anual growth rates in prices  of 1.5%/1.6% in two years. Why is inflation not rising despite the improvement in the economy? Perhaps it’s due to circumstantial factors. Although most economists focus on structural factors.

A long period of low inflation, and the credibility itself of the central banks, in a context of exceptional expansionary monetary policy over too long a period, will without doubt have curbed expectations for increases in prices and salaries. If this is temporary, then the central banks should begin to normalise their monetary policy, bearing in mind that its success in limiting inflation tensions is based precisely on its preventive nature. Whatsmore, very few people talk about restrictions on financial conditions. The debate is focused more on limiting the current expansion which some believe is excessive. They also consider it carries risks which generate financial instability and distortions in the markets in the medium-term.

But there is also another tide of opinion which values inflation contention as structural. To defend their view, people allude to demographic factors, the rupture of the Phillips Curve and the digital revolution, amongst other issues. What the BIS says about this in its latest quarterly report is interesting. It recommends that if the central banks believe we are in a scenario of low structural inflation, they lower their inflation targets. In this way they would have more room to move in terms of normalising their excessive expansionary monetary policies, thus avoiding the potential negative consequences. This seems reasonable.