Monetary policy accommodation has consequences, a Barclays report points out, as fiscal stimulus and contritely named helicopter money may point to the next reluctant leg in governments trying to jump start generally well-performing regional economies. But is there a point when too much debt overwhelms? Or don’t central bank balance sheets matter?
Is there a limit to how far non-conventional monetary policy can extend?
There is a decided trend divergence among central bank balance sheets. As the Bank of Japan and European Central Bank balance sheets sprint to over 80% of their regional Gross Domestic Product – with projections having them hit 100% as 2018 approaches – the U.S. Federal Reserve, currently near 65%, is projected to slowly fall.
There has been an active discussion among market professionals and certain market focused economic PhDs that a “limit” to government debt exists. This red line in the sand is mostly considered the point at which market forces, having witnessed the abandonment of free market principles and traditional supply and demand value economics, withdraw support from the market, leaving the central bankers as the primary bid and ask in a centrally planned market.
There were limits put in place on central bank asset purchases for a reason. Having an “artificial bid,” as Bill Gross and several market participants call it, predominate a market is unhealthy. The central bank central planners were not allowed to exceed a 33% market asset ownership threshold, which keeps free market forces alive. It isn’t much discussed in the mainstream, but this is a key point of defense for free market advocates. With an eye to central banks not entirely overwhelming market forces, the limit is in place to keep a competition buffer in place.
There is a problem, however. The magic people don’t like to face market forces. As the ECB is approaching the limits of what it can purchase, talk of breaking the previously set rules predominate. As 2017 comes to a close, those limits could be breached. The problem becomes the higher the level of central bank market participation the higher the potential for market distortion, a point noted by JPMorgan’s Marko Kolanovic yesterday. Kolanovic has spoken forcefully regarding unconventional central bank monetary policy in the past. When presidential aspirant Donald Trump called the markets “artificial,” there was a nod of agreement among market participants regardless of what you think of his more controversial positions.
Questions central bankers ignore
“QE has led to unprecedented balance sheet expansion by central banks; it has depressed yields and generally pushed assets to valuations often no longer supported by ‘fundamentals,’” analyst Christian Keller wrote in the Barclay’s report titled “Conundrums of a policy maker: The limits of policy stimulus and the remaining options.”
Thoughts of “no longer supported by fundamentals” lead to three questions that market participants raise but central bankers generally appear to ignore: 1) Why are such extreme emergency actions needed when the economy is, by many objective measures, doing well? 2) What was the central bank risk modeling on the addictive properties of quantitative stimulus before launching the program? 3) What is the risk modeling, if any, regarding central banks being “wrong”? What is the worst case risk modeling? And, if you haven’t conducted such risk modeling, why aren’t these questions allowed in the public arena?
As Eric Peters noted yesterday, PhD central bankers don’t like to be faced with a dilemma. “They’re too smart for that.”
But a free market dilemma is upon us and the answer being implemented is more obfuscation.
The report noted quantitative easing policies “are becoming more complicated, as some (central banks) running out of the assets they would typically buy for monetary policy objectives,” which primarily includes risk free govt bonds. Central bankers are “venturing into asset classes that imply higher risk and raise potential governance / moral hazard issues,” specifically investing in equity markets, the report said.
The report didn’t define “moral hazard issues,” as discussion of free market principles amid the central bank elite appears to be a no go area.
Helicopter money – Negative interest rates are achieving policy objectives, ECB officials claim
Perhaps the most controversial central bank policy is negative interest rates. Here the Barclays reports notes differential impact based on the structure of the economy.
The determinants of the negative rate policy’s impact is dependent on banks’ excessive liquidity, behavior of savers through bank deposits – do they engage in a search for yield — corporate funding relative to banks vs. capital markets as well as particularities of mortgage market having an impact on policy outcome. Freedom of choice with how to save, spend and invest money appears to be an anathema.
The report noted that a “cashless” society would “overcome the challenges” of negative interest rate policy – giving the masses of money holders little choice on how to use their assets. But the cashless society “would itself face large (political / institutional) challenges.” In fact, negative interest rates could reach the point of a “reversal rate” where they “would not only have diminishing returns but become counter productive” and cause financial disintermediation.
This is, of course, polite talk with very specific warnings attached. As ECB President Mario Draghi said today that negative interest rates were achieving their goals, indicating a lack of concern over how banks are being impacted. The question is what comes next? If negative interest rates only have a small relative impact on the growth of the real economy, what is left in the policy tool kit? Not much.
The test of the question of “do central bank balance sheets matter” comes when helicopter money is considered
With central bank monetary policy reaching the end of its usefulness, it is fiscal stimulus on the horizon to boost a sluggish economy. Spending that improves roads, bridges, schools has a direct impact on a larger percentage of a nation’s population, but there are debt issues.
“Fiscal expansion can in principle help to boost growth, at least in the short term by adding demand, and possibly also the medium- and longer term if supporting supply side (eg. infrastructure investments),” the report noted. “The low interest rate environment in principle supports fiscal stimulus, as it makes funding easy and cheap.” However, with government debt-to-GDP ratios already “very high,” pointing to a line in the sand, and doubts about the sustainability of debt in the longer run being prevalent, it is not clear how private market players would react to reaching extreme levels of debt to GDP levels.
The answer may lie in not having government debt used to finance fiscal stimulus, a controversial topic that centers on the importance of the central bank balance sheet.
At the center of a significant monetary experiment is the “helicopter money” concept. This is where the central banks, not officially part of “government,” engage in direct stimulus in the economy.
The Barclays report points out that helicopter money could actually take the form of “printing bills and handing them out to citizens,” which would be the widest distribution of stimulus in history. More traditionally targeting stimulus at those who pay high taxes, tax cuts could somehow ensue – although the report was unclear how a central bank could be involved in supporting a tax cut. The most likely form of helicopter money involve increased government spending on targeted infrastructure.
These will test the limits of nonconventional monetary policy. Do central bank balance sheets matter? Is debt really created if a central bank is responsible? Will this result in a market crash where market manipulation was primary causation for the first time in history? History will only know. These are “magic people,” the common rules don’t often apply.