Central banks tiptoe to massive unwinding of economic stimulus

To taper or not to taper? That’s the question central bankers face as they debate when they should reverse the massive economic support measures they deployed last year to prevent a pandemic-induced Great Depression.

“The withdrawal of monetary and budgetary support is inevitable. The key issue is timing, ”said Eva Sun-Wai, fund manager at M&G Investments.

As the US Federal Reserve (Fed) and other central banks hold meetings this week, here are some key questions regarding their monetary policies:

What measures are in place?

The Fed, the European Central Bank (ECB) and their counterparts in Japan, Britain and elsewhere cut interest rates and launched massive asset purchase programs last year to avert economic catastrophe .

The goal of the programs is to keep the economy booming by making borrowing money less costly for individuals, businesses and governments.

The Fed, which begins a two-day policy meeting on Tuesday, cut rates to zero at the start of the pandemic in March 2020.

To provide liquidity to the world’s largest economy, it buys at least $ 80 billion a month in Treasury debt and at least $ 40 billion in agency mortgage-backed securities.

The ECB has a € 1.85 trillion Pandemic Emergency Purchase Program (PEPP), allowing the bank to purchase financial market assets such as bonds, raising their price and lower interest.

The ECB has kept the rate on its main refinancing operations at zero.

Why no rush to get out?

Inflation has skyrocketed around the world, raising market expectations that central banks will tighten money supply to drive down prices and keep economies from overheating.

Central banks in Brazil, Russia, Mexico, South Korea, the Czech Republic and Iceland have raised interest rates this year.

But the Fed, the ECB and the Bank of England (BoE), which is also meeting this week, have so far all held their own.

Fed, ECB and BoE officials have insisted that inflation is only temporary and a consequence of price recovery after declines at the height of the pandemic last year.

Policymakers want to avoid hurting economic recovery by withdrawing too much support too quickly.

What are they saying?

Markets have reacted to all economic indicators – from inflation to unemployment to consumer spending – in a guessing game as to whether they will force central banks to adjust their policies sooner or later than expected.

Bank officials, for their part, carefully weigh their words.

Fed chief Jerome Powell said in August that the central bank could “start slowing down the pace of asset purchases this year,” but he has remained low-key on the timing.

The ECB went further this month, deciding to slow the pace of its monthly bond purchases, but it did not change the size of the program or its March 2022 end date.

“It’s far from a ‘total cone’,” said Andrew Kenningham, chief economist for Europe at Capital Economics.

The head of the ECB, Christine Lagarde, was herself clear: “The lady does not shrink,” she said.

Markets are waiting for a clearer signal from the ECB in December.

Have central banks succeeded?

The global economy is recovering as individuals, businesses and governments have taken advantage of ultra-low interest rates.

Governments, meanwhile, have injected $ 16 trillion into fiscal stimulus programs around the world, according to figures from the International Monetary Fund.

“We have learned a lot from previous crises and the management of the COVID-19 crisis has been almost perfect from an economic standpoint,” said Vincent Juvyns of JPMorgan Asset Management.

“The recovery is clear and massive and we have not experienced mass unemployment or a wave of bankruptcies,” he said.

Rating agency S&P Global said the default rate in Europe is expected to decline in the near term, “particularly if the policy withdrawal goes in an orderly fashion, as expected.”

What are the negative effects?

Critics say ultra-accommodative monetary policies only worsen inequality by inflating the prices of financial assets and raising real estate prices.

The ECB is defending its actions by citing studies by affiliate researchers saying its policies have helped curb unemployment, giving a boost to lower-income households who have also become homeowners thanks to lower rates.

A report by the Organization for Economic Co-operation and Development (OECD) in September expressed concerns about the potential negative side effects that extending easy money policies could have on the prices of financial and real estate assets.

“Central bank interventions only make sense if they prevent a recession,” said Nicolas Veron, an economist at the Peterson Institute and the Bruegel think tank.

“If they are no longer needed to avoid a recession, they have a much more negative effect than a positive one,” he said.


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