As the world’s central bankers gather in Jackson Hole, Wyoming, for their annual retreat, it would be no surprise if they opt for a quiet walk in the beautiful Grand Teton National Park during breaks in the programme, rather than the white-water rafting that is also on offer.
The crisis that has engulfed global financial markets is two years old and next month is the anniversary of the uncontrolled failure of Lehman Brothers that led to a “sudden stop” in the global economy and the deepest post-war recession. For policymakers, it has been a white-knuckle ride.
The mood should be a bit better than last year’s meeting. The disorderly collapse of Lehman Brothers helped to turn a global financial crisis into a global recession. The efforts of governments around the world, including massive liquidity injections and a co-ordinated central bank rate cut by the Federal Reserve, Bank of England, European Central Bank and three other central banks, helped to prevent a repeat of the global depression.
But it is certainly too soon for anyone to relax. There are big questions over the extent to which the current bounce in the cyclical economic data will translate into a sustained recovery and, related, over the need for more policy stimulus — with the Bank of England leading the charge.
This year’s symposium — which is organised by the Kansas City Fed — starts today and brings together central bankers and academic and market economists from around the world. The formal agenda focuses on an assessment of the monetary and fiscal policies enacted globally to stabilise economies and financial markets over the past year. The forward-looking assessment on “what next” will be equally, if not more, important.
Some of the policy response over the past year has been formally co-ordinated, including co-ordinated cuts by the central banks that were delivered six weeks after last year’s Jackson Hole meeting. Some of it has been informally co-ordinated, including other countries following the UK lead in recapitalising their banking systems. And across the board we have seen large-scale fiscal stimulus, another item on the Jackson Hole agenda.
Other interventions have reflected respective countries’ institutional framework. The US and the UK have gone into partnership with their respective finance ministries, including quantative easing — the central bank buying the Government’s debt.
The ECB, without a governmental counterpart, has focused instead on pumping massive liquidity into the banking sector. But it joined its Anglo-Saxon counterparts in direct interventions in markets with its programme to purchase the asset-backed securities issued by European banks.
While the details differed across countries, the guiding principle was “whatever it takes”. And the efforts have been successful in preventing collapse, evidenced by the gradual normalisation of financial markets. Monetary and fiscal stimulus has prevented an even deeper drop in economic activity, though it has done little to prevent very sharp rises in unemployment to above 9 per cent in the US and eurozone and not far behind in the UK. The waning impact of policy stimulus over the next year and the weakness of income growth at a time of high unemployment and significant economic slack are two key challenges to economic activity.
While there was partial co-ordination of policy interventions over the past year that helped to stem the rout, it is far from clear that there will be much co-ordination in the coming months or in the eventual exit phase, which could threaten yet more volatility. In less desperate times, co-ordinated measures are difficult, owing to differences in analysis, in initial conditions and not least owing to different political pressures.
It is a shame that Mervyn King, Governor of the Bank of England, is not scheduled to attend the Jackson Hole meeting, since among central bankers his recent comments have been the most interesting and proactive. Mr King has sounded a loud warning on the vulnerability of the recovery and the need for greater policy stimulus. At its last meeting, the Monetary Policy Committee voted to increase its quantitative easing programme by £50 billion to £175 billion. The minutes of that meeting showed this week that Mr King and two of his colleagues favoured a bigger increase and will quite likely vote to increase the programme further at a subsequent meeting. In contrast, the Federal Reserve has signalled that it will wind down its own quantitative easing programme.
Moreover, Mr King and his colleagues have been blunt in their reasoning. Past falls in asset prices, high levels of private and public sector debt, and high unemployment are likely to hold back spending. Given the risks to the outlook, the risk of doing too little was far greater than the risk of doing too much. Moreover, insufficient stimulus could cause a loss of confidence in the ability of policymakers to support recovery and a Japanese-style decline in inflation expectations that becomes self-reinforcing. In the event of a significant downturn in the global economy in 2010, Japanese- style policy exhaustion will be a significant risk.
The sequencing of recoveries and eventual withdrawal of emergency policy stimulus will also be crucial to navigating the next stage of the crisis, particularly for fixed income markets and currencies. An unresolved question is how and when the US dollar will adjust against the Chinese and other emerging market currencies that are fully or semi-fixed, to allow a rebalancing of the US economy towards exports as households in that country increase their savings.
For investors, the conclusion is that caution on risk assets is warranted given the threats to robust and perhaps to sustained recovery in 2010. Ongoing deleveraging, a shrinking financial system and the waning support from government stimulus do not provide the foundations for a V-shaped recovery. Recent downward moves in risk assets suggest an adjustment to excessively optimistic expectations.
Meanwhile, something that might feature on the formal agenda for next year’s Jackson Hole meeting is the question of how to ensure that a crisis on this scale and scope does not happen again — or at least not for a long time. Ben Bernanke, chairman of the Federal Reserve, in his old life as an academic economist, gave a presentation at Jackson Hole in 1999 that provided an intellectual framework for the approach favoured in the US and in most other countries of allowing asset price bubbles to play themselves out, rather than using monetary policy and regulation to “lean against the wind”. It is an interesting question whether the experience of the past two years may have caused him to reconsider.
• Andrew Balls is a managing director of PIMCO, the global investment manager
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