The Federal Reserve Building on Constitution Avenue in Washington on March 27, 2009.J. Scott Applewhite
The knock against Christine Lagarde during her coronation as managing director of the International Monetary Fund in 2011 was that she lacked the technical prowess of all those old guys who preceded her.
Well, Ms. Lagarde, a lawyer by training, looks rather astute after warning on Monday that it would be a mistake to assume that the global stock rally engineered by the European Central Bank, the Federal Reserve and the Bank of Japan would last.
As if on cue, stock markets tumbled. The Standard & Poor's 500 Index dropped more than 1 per cent on Tuesday, accelerating a slide that began at the end of last week. Equities dropped by similar or greater amounts pretty much everywhere else in the world, too. The declined in global stock prices continued Wednesday.
The trigger appears to be fleeting confidence in the ability of central banks to generate economic growth.
Investor anxiety flared as Charles Plosser, president of the Federal Reserve Bank of Philadelphia, expressed serious doubt in the efficacy of the Fed's latest attempt at quantitative easing. "We are unlikely to see much benefit to growth or to employment from further asset purchases," Mr. Plosser said in a speech Tuesday. "Conveying the idea that such action will have a substantive impact on labour markets and the speed of the recovery risks the Fed's credibility."
If stock markets turned on Mr. Plosser's remarks, then there is deepening unease among investors over the ability of monetary policy to generate economic growth.
Mr. Plosser currently is an outsider at the Fed. He attends the meetings of the policy committee, but he is not among the 12 members who votes on policy. (He isn't scheduled to return to the voting group until 2014.)
Even assuming he has outsized influence over his peers, Mr. Plosser's views on Fed policy are well known. He thinks the U.S. economy will expand by about 3 per cent in 2013, which ranks him among the more optimistic forecasters in the world, let alone at the Fed. As a result, Mr. Plosser has made clear for some time that he thinks further attempts to jolt the economy only risk stoking inflation.
Mr. Plosser also overstates what the advocates for additional bond buying are promising. At a press conference following the Fed's Sept. 13 announcement, Fed chairman Ben Bernanke stressed at least a half-dozen times that monetary policy would not be a panacea for the U.S. unemployment problem. "We'll do our part, and we'll try to make sure that unemployment moves in the right direction," Mr. Bernanke said. "But we can't solve this problem by ourselves."
Ms. Lagarde had a similar message: The central banks have done their jobs, and it's time for politicians to take over. That's not going to happen soon. In the United States, fiscal policy is frozen until at least after the November presidential election. In Europe, the situation is so complex that it is unreasonable to expect any breakthrough moments in the near term. The best that can be hoped for is politicians avoid making the recession worse before the end of the year.
That brings us back to the central bankers. It may be unfair, but they are going to have to find a way to convince financial markets that their policies are strong enough to keep the global economy afloat.
Mr. Bernanke already is trying to do this. He is calmly asserting that all the best evidence shows that by promising to keep rates low, and by purchasing bonds, the Fed should be able to "nudge" the economy in the right direction. Yet he remains realistic. "We don't have tools that are strong enough to solve the unemployment problem," he said.
So it must be a concern when investors pay more attention to the naysayer without a vote than they do the chairman of the policy committee.
Charles Evans, president of the Federal Reserve Bank of Chicago, is the anti-Plosser. He has advocated more aggressive policy for two years, and said in a speech Wednesday that he "strongly" supports the Fed's new measures. A preoccupation with unintended consequences, when real consequences are so evident, risks repeating the mistakes of Japan and its "lost decade" of stagnant growth in the 1990s. "That type of passivity is a gamble that is not worth taking," Mr. Evans said.
Stocks remained lower after the release of Mr. Evans's remarks. Amidst fresh worries about Spain's ability to restrain its deficit, many investors, it seems, still were listening to Mr. Plosser.