Does expansionary monetary policy have a future? How can it create more room for maneuver again? Claudio Borio considers many ancient wisdom to be worth examining. And in Australia it is being discussed whether the central bank council there understands anything about monetary policy at all.
The annual conference “The ECB and its Watchers” in Frankfurt traditionally has a very international focus and is filled with both supporters and critics of current monetary policy. This creates different points of view and sometimes lively discussions. Of the numerous interesting contributions this year, Claudio Borio’s lecture should be briefly discussed here. Borio is head of the money and economics department at the Bank for International Settlements (BIS), the bank of central banks. He has been known for many years as a critic of the monetary policy of the major central banks – without falling into the doom and gloom of catastrophe economists.
The following points are important:
- For the foreseeable future, Borio will necessarily continue to see monetary policy in an expansionary crisis mode. He doesn’t criticize that. He fears, however, that monetary policy instruments that were previously perceived as extraordinary, such as bond purchases and negative interest rates, will become instruments for ordinary monetary policy after the crisis. He doesn’t think that’s a good thing.
- Borio does not deny the positive effects of buying bonds in times of crisis. This instrument actually worked better than feared. However, the positive effects of such instruments diminished over time and the negative side effects should not be brushed under the table.
- He is very critical of the sustained use of announcements in monetary policy to influence the inflation rate. This can be seen as a criticism of current discussions in central banks, by announcing (“Forward Guidance”) higher inflation targets to induce people to spend more in order to achieve higher inflation. Studies have shown that many people base their inflation expectations on inflation rates from the recent past rather than on central bank inflation targets. People have long since realized that central banks cannot precisely control the inflation rate.
- The central banks should also accept that they have lost at least some control over inflation. A close connection between economic growth and the inflation rate (“Phillips curve”) can no longer be demonstrated.
- However, this also makes the strategy of central banks questionable, in the event of very low inflation rates wanting to generate more economic growth and inflation through more and more monetary policy easing. Borio thus criticizes the mantra: “The way to higher interest rates is first through rate cuts.”
- Borio has long criticized the tendency of central banks to explain low key interest rates with a secular decline in the so-called natural interest rate, to which monetary policy has to react. Borio does not deny a secular decline in natural interest rates, but he believes that the central banks themselves contributed to that decline.
From this it follows: Borio calls for accepting the limits of monetary policy action and making monetary policy more long-term instead of reacting in the short term to every missed target. And he recalls that there are other policy areas that have responsibility for economic well-being. This also includes the need to implement structural reforms.
The allegation of incompetence is a bit astonishing, because the governor of the central bank, Phillip Howe, enjoys high international reputation and the particularly hard-attacked Vice-Governor Guy Debelle as well as Howe did his doctoral thesis at the Massachusetts Institute of Technology (MIT) and thus at one of the leading business schools in the world. The Reserve Bank is accused of not loosening its monetary policy energetically enough in view of the consequences of the corona crisis and that it has so far refrained from both bond purchase programs and negative interest rates.