Central banks’ role as stabilisers of the present six years long crisis is undeniable. The Federal Reserve as well as the European Central Bank have been forced to use all their financial weapons to decrease interest rates and inject liquidity for companies and households. Boosting the so called real economy has been their final goal all the time. In fact, they keep on working on that, but with different approaches, sometimes even paradoxical.
Spanish analysts at Bankia stressed on Thursday the fact that “the Fed seems to bet on a monetary stimulus reduction, which will probably start on next December, while the ECB has just cut interest rates to 0.25%, its record low, but don’t stop suggesting that it still has enough tools to promote the regional economy. The ECB appointed openly on Wednesday that it may fix the deposit rate at a negative level or even buy European banks assets”.
Five years ago, after Lehman Brothers’ credit crunch, both central banks did departed from the same point, however. When the Fed steered its overnight interest rates almost to zero on December 2008, the traditional monetary policy ceased to be the support for market expectations and the global central banks, included the European one, held with no doubt unconventional measures.
Professor of economics at Ghent University (Belgium) Gert Peersman has made a review of those unconventional policies adopted by the Federal Reserve and the European Central Bank in order to know how the transmission mechanism of such policies to the real economy differs from that of conventional interest rate changes, and the relevant macroeconomic consequences.
In a White Book for the Global Financial Institute of Deutsche Asset & Wealth Management, Peersman concludes that the unconventional measures of central banks “were effective in stabilising financial markets, reducing (long-term) interest rates, and stimulating economic activity. At the moment, there are no risks to price stability. As long as economic activity is below its full-employment level, there is no reason for inflation to take off as a result of the abundant liquidity in circulation”.
In this common way of unconventional policies followed by the Fed and the ECB, their starting points were also different. The measures were alien to the principles of both, that is a truth, but they reflect the differences in their economies’ financial structures. “The euro area’s financial system centers on commercial banks, while the United States’ system is based primarily on capital markets. This explains why the Fed largely intervened directly in financial markets, whereas the ECB focused on measures to increase bank lending,” professor Peersman explains.
The concept of “forward guidance”, in which central banks makes their suggestions and inform about their forecasts, were not communicated on the same line either. The ECB has always been more careful with its communications. According to the White Book, “forward guidance only crossed the Atlantic in July 2013, when for the first time the Governing Council of the ECB announced in its press release after its monthly policy meeting that it expects the key interest rates “to remain at or below their current levels for an extended period of time.” It is an open issue whether the ECB will use forward guidance more aggressively in the near future and whether it will become more concrete about the exact time frame over which interest rates will remain low”. On the other hand , the Fed has always offered federal funds rate forecasts, and not any explicit commitments. Each of these statements nevertheless resulted in significantly reduced forecasts for the federal funds rate by financial markets.
About long-term effects of unconventional policies on national economies, Peersman warns that when the economy recovers, central banks will have to remove monetary stimulus by raising interest rates and shrinking their balance sheets. Central banks will have several tools to organise their exit strategy, but they involve the risk of being too weak or being introduced to late. If it ocurred, the economist thinks it is possible that inflation will maintain at relatively high levels for some time. For the euro area, this will be first in the North than in the South due to high unemployment and low capacity utilisation rates, wages and prices. Only competitiveness will enable inflation rates across countries converge.