The European Central Bank is looking to the U.S. Federal Reserve for confirmation that extraordinary monetary stimulus works.
“If indeed the Fed feels confident enough, say in December, to raise rates,” it would prove that “monetary policy can do it,” ECB Vice President Vitor Constancio said during a panel discussion in Frankfurt on Friday. “I hope if and when it happens, it will lift animal spirits everywhere. So we are looking forward to that one.”
Constancio’s comments come at a key point for both central banks. The ECB is trying to figure out how it can keep its bond-buying program going for long enough to revive euro-area inflation, while the Fed is gauging how cautious it can afford to be in raising borrowing costs.
The U.S. central bank left its policy rate unchanged on Wednesday to await more evidence of progress on inflation and employment amid slowing global trade, though signaled an increase is still likely by year-end. Two weeks earlier, the ECB kept its rates and pace of bond purchases unchanged as it gave its technical committees a “full mandate” to propose redesigns for the quantitative-easing program.
Constancio said the ECB’s measures are taking longer than expected, in part because of inadequate government support.
“We all hoped that the reaction of the economy would have been much quicker as a result of the expansionary monetary policies that were put in place,” he told the panel. “It would be nice if monetary policy would be helped by other policies in trying to achieve a quicker close of the output gap and a quicker normalization of the inflation rate.”
As central banks have delved further into extraordinary measures to hit their mandates, and generally fallen well short of their inflation targets, they’ve also stepped up their calls for governments to do more with targeted fiscal stimulus and structural reforms. The refrain is that monetary policy cannot be the only game in town, and investors are taking note.
Just days after the Bank of Japan said it’ll actively manage bond yields to reach its inflation goal of 2 percent, yields on longer-term debt have jumped. That’s a sign BOJ Governor Haruhiko Kuroda has failed to convince traders he has the tools to achieve his goal.
Even so, governors at the Frankfurt conference said they’re confident of success.
“They are trying to do as best as they can in terms of getting inflation up in Japan. And if they are successful, if the ECB is successful, if the Federal Reserve is successful, in my case, coming from a small open economy, that will be helpful for us as well when it comes to bring inflation up,” said Stefan Ingves, the governor of Sweden’s central bank. “If all of us are heading in the same direction — increasing the money supply, keeping rates very, very low — that also increases the likelihood of getting global inflation up.”
The conference was dedicated to macroprudential policies, intended to temper any financial imbalances from central banks’ unprecedented easing. ECB Governing Council member Francois Villeroy De Galhau, the Bank of France head, noted that loose monetary policy could create risks to financial stability over a longer period and so has its limits.
“Nominal interest rates are now probably close to a low point, which doesn’t imply they will rebound soon,” he said. “We know there is lower bound, even if we don’t know exactly where it is, somewhere slightly below zero.”
Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, sounded a cautionary note.
He warned that what could tip the scale against deflation in the end might be the backlash against globalization that is gaining traction across developed economies. If so, the solution “would be worse than the problem,” he said.