Central banks – who’s next?

Central banks in Europe and Japan have pushed short-term rates into negative terrain, meaning they are charging banks that leave money on deposit with them. Ms. Yellen, Chairwoman of the US Federal Reserve Bank,  said she didn't think the Fed would need to do this, but it should be prepared if the economy sinks and such a step is needed. Prominent bond managers like PIMCO answered that they think negative interest rates won’t work. In his most recent book, „The Only Game in Town”, Mohamed A. El-Erian, Chief Economic Advisor Allianz SE, discusses the role of central banks. Here are his thoughts on what is happening.

 

Central bank activism did not stop with their success in normal­izing utterly dysfunctional markets and calming a financial crisis that had brought the global economy to a virtual standstill. Having suc­ceeded, they then found no one to hand off to for the next stage of the economic recovery. As such, they felt that they had no choice but to take on unprecedentedly large responsibilities for the macroecon­omy. This was not a power grab. Nor was it something that central banks were seeking. Instead, with political dysfunction paralyzing other policymakers with better policy tools, central banks felt a moral and ethical obligation to do whatever they could to buy time for the pri­vate sector to heal and for the political system to get its act together and assume its economic governance responsibilities.
 
In this new role, central banks did more than assume a leadership role. They also supplied almost the entire content of the policy re­sponse, and did so with inherently partial and blunt measures. Being the only game in town, central banks found themselves pushed ever deeper in experimental policy terrain, and they have stayed there much longer than anyone anticipated or may have hoped for initially. Policy making often entails difficult trade-offs. This phase of mod­ern central banking has been no different, though with one major qualification: This time around, central banks have not been able to resort to reliable insights and information from historical precedents, analytical models, or past policy experience. There are none that can guide them properly and inspire well-placed confidence.
 
On the positive side, the central banks’ unconventional measures did manage to buy considerable time and space for others to get their act together. They facilitated major private sector balance sheet re­pair, starting with banks and then corporations and households. They contributed to growth, albeit frustratingly tepid, and, in the case of the United States, to significant job creation. Like dedicated engineers, central banks constructed the best bridge possible with the limited materials they possessed. But no matter how long a bridge they have built, the right destination was never theirs to deliver on their own.

Mohamed A. El-Erian: “The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse”.
Mohamed A. El-Erian: “The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse”.

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