Perhaps a small warning within the lecture given by PIMCO’s Mohamed El-Erian at the St Louis Federal Reserve last night for those who think our own central bank should go down a similar road to other developed nations. This is a marvellous speech, available in full here.
Here are the key points, beginning with his soon-to-be-classic phrase:
In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!
- Central banks have had to innovate and stretch policy tools and mandates, including the use of liquidity facilities and communication, to render less disorderly a set of fundamental multi-year economic and financial re-alignments.
- While initially successful – indeed, critical to avoid a global depression – the policy stance, both here in the United States and over the Atlantic in Europe, appears now to increasingly involve an unfavorable change in the balance between what Chairman Bernanke has labeled as the “benefits, costs and risks.”
- Having built a bridge for other policymakers and for healthy balance sheets in the private sector, central banks must now hope that a more timely, comprehensive and effective response will finally be forthcoming (and push for it, as appropriate).
- Should this fail to materialize, central banks risk finding themselves having built expensive bridges to nowhere and, accordingly, will come under severe pressure with implications for the future of central banking itself, as well as for the welfare of economies at the national, regional and global levels.
- Meanwhile, the ripple effects from central bank policies will increasingly be felt in the functioning and, in some cases, viability of whole segments of the financial markets – thus adding to the need for both public and private entities to become more intellectually and operationally agile.
El-Erian was clear that central banks alone cannot “carry the bulk of the policy burden”, mainly because of the dual risk of running out of monetary tools to counter deleveraging whilst growing the risk of unintended consequences.
He covered the reality that central banks need help from the fiscal policy makers, i.e government, in realigning the fundamentals behind economies – particularly housing and housing finance – via a de-risking of the financial sector and other policy initiatives, which have so far been kept off the table for political expediency.
His concluding remarks, quoted in full below, highlight two things for me from an Australian perspective.
First, where are the Australian businessmen who are making statements like this and highlighting the risks inherent to our politico-housing complex? And I mean past a vested interest.
Second, why are Australian mainstream economists not getting the point that leaning on the RBA to do all the work of government policy is a stance doomed to fail? Are we truly that arrogant to believe that Australia is “different”?
In the period ahead, central banks will need to consider how best to navigate what may increasingly morph over time into a bi-modal distribution for expected economic outcomes, especially in Europe. They could also find themselves countering even more complicated self-insurance behavior on the part of the private sector. And the political context could get more difficult.
Rather than lead the parade of advanced nations – which they have done so skillfully and boldly since the outbreak of the global financial crisis – central banks risk find themselves increasingly in the position of followers. And they will do so in the context of uncertainties about the overall construct of a global economy that is now operating with a weaker traditional core but no ready and able substitutes.
The welfare of millions in the United States, if not billions of people around the world, will have suffered greatly if central banks end up in the unpleasant position of having to clean up after a parade of advanced nations that headed straight into a global recession and a disorderly debt deflation. Let us therefore hope that central banks will, instead, find themselves part of a much broader policy effort headed toward high sustainable growth, ample job creation, less income and wealth inequality and financial soundness.