Central banking in the post-crisis era is a massive a road-side assistance program.
Bank of Mexico governor Agustin Carstens gets the credit for this metaphor. Mr. Carstens told an audience in Washington on the weekend that it should think of monetary policy like one of those tiny spare tires that are meant only to get you to the next gas station. But if you drive on the doughnut too long, you’re asking for trouble. “If nothing is done, you will be left in the road,” Mr. Carstens said.
The world’s largest economy is testing the limits of Mr. Carstens’s spare-tire theory of monetary policy. Problems with the housing market, the federal budget deficit, and financial regulation must all be fixed before the U.S. economy returns to its former glory. There’s little reason to expect any of this will be achieved before the mechanic-in-chief is chosen in November’s presidential election.
So until then, it’s up to Federal Reserve chairman Ben Bernanke to keep the U.S. economy moving. This week will determine how he intends to do so.
On Tuesday and Wednesday, he will lead a meeting of the Fed’s policy body, the Federal Open Market Committee (FOMC). Policy makers will adjust their economic outlooks, including their forecasts for when interest rates will rise from the current-level of near zero. Mr. Bernanke will attempt to explain all in a press conference on Wednesday afternoon.
There is much debate about whether the Fed intends a third asset-purchase program, known as quantitative easing. With the benchmark rate at zero, purchasing hundreds of billions of dollars worth of Treasuries or mortgage-related assets is the best tool the Fed has to lower borrowing costs. The Fed has twice resorted to QE, and while unconventional, Mr. Bernanke has expressed confidence the policy is effective.
A third QE program seems unlikely. At their last meeting in March, most policy makers indicated they were comfortable with their current stance so long as indicators continued to show the economy is getting stronger.
Last week, the International Monetary Fund said U.S. gross domestic product would expand 2.1 per cent in 2012, compared with an estimate of 1.8 per cent in January, and the Bank of Canada raised its outlook for U.S. growth to 2.3 per cent this year from 2 per cent. It seems likely that the Fed will increase its own forecast this week, which would argue against the need for new stimulus measures.
“QE3 doesn’t make sense unless Spain blows up,” said Sébastien Lavoie, a former Bank of Canada economist who now works at Laurentian Bank in Montreal, alluding to the European debt crisis, where Spanish yields show that investors remain far from confident that European leaders have contained their troubles.
Mr. Bernanke will go into the FOMC deliberations this week with fresh assessments on the situation in Europe and the global economy after seeing international counterparts over the weekend meetings of the Group of 20 and IMF in Washington. The mood was slightly more optimistic, and the IMF managing director Christine Lagarde raised more than $400-billion (U.S.) in additional funds for her crisis-fighting arsenal.
But that money is both a comfort and a warning. Combined with Europe’s $1-trillion (U.S.) financial backstop, the international community appears to have mustered considerable resources to keep countries and banks from imploding. Yet the fact that officials feel the need to raise the money shows the world economy is far from healed. “There will be pitfalls,” Singapore’s finance minister, Tharman Shanmugaratnam, said.
That’s why central banks are sticking with emergency settings even though the worst of the financial crisis passed more than two years ago. Monetary authorities in Brazil and India cut interest rates last week and the Reserve Bank of Australia indicated that it could do the same, depending on how the next run of inflation readings turn out.
The Bank of England and the Bank of Canada shifted away from further stimulus, but neither is close to actually tightening policy.
In the first of his four lectures at George Washington University in Washington last month, Mr. Bernanke told the assembled undergraduates that the Great Depression was made worse because the Fed panicked and raised borrowing costs too soon. “If you accept that, you need to be attentive of where the economy is, and not move too quickly to reverse policies,” he said.
It was the most significant thing he said during more than four hours of teaching. Central bankers can’t repair what ails economies, but they can buy time for governments to make structural changes or for businesses and consumers to gain confidence. Mr. Bernanke has installed a spare tire on the U.S. economy. Now he can only hope it doesn’t blow up.