By Balazs Koranyi, Leika Kihara and Howard Schneider
FRANKFURT/TOKYO/WASHINGTON (Reuters) – Today’s central bankers have the unenviable task of weaning a pandemic-hit global economy off cheap money amid unprecedented sovereign debt levels and with asset prices inflated by years of stimulus and near-zero interest rates.
The risk of making mistakes is even greater because many have never raised interest rates before, and few have had to face inflation that has risen at a multi-year pace and pushing beyond the target.
Peter Ireland is an economics professor at Boston College.
Inflation was a topic that had been discussed for many years before the recent price rises caused by rising energy costs and problems in global supply chains.
The decline in global growth from the highs of 1980s double-digits has been explained by a variety of factors, including technology, China’s cheap exports, population age, and global recessions.
Although some central bankers of today had the ability to reverse a moderate rate hike in the second quarter of last decade, others don’t have the same experience.
The current Bank of Japan board of nine has never instituted any rate hikes. For the 2007 rate hike, even Deputy Governor Masayoshi amamiya played a role in policy-making to offset what was a temporary reprieve from inflation.
Klaas Knot, the Dutch chief of the central bank, was in his second week in office at the European Central Bank when the ECB raised its interest rates for 2011. This is his first time that he has been a member of the 25-member current Governing Board.
Some suggest the fact the two 2011 hikes – made on the eve of the euro zone debt crisis – have gone down in history as the ECB’s biggest policy error in two decades of existence could create a “once bitten twice shy” mentality.
Carsten Brzeski, an ING economist said that there is a danger of making a policy error of being too dovish over too long. This was partly due to institutional memory.
He said that even if the policymakers weren’t there, they would always be remembered the 2011 error or the 2008 rise. This was referring to a rate increase cycle which occurred on the edge of the financial crisis and had also needed to be reversed quickly.
Main Fed, ECB, BOJ rates https://fingfx.thomsonreuters.com/gfx/mkt/zdvxoqmlbpx/Pasted%20image%201643100080295.png
Governor. Chris Waller and Gov.
This round of rate rises, however, was not as large-scaled as the inflation wars fought earlier by Fed leaders. Paul Volcker’s decision in 1980 to prevent spiralling prices, with a record 20 percent benchmark rate in order to stem them, came at the expense of deep recession.
The most recent cycle was slow to get going – with a single quarter point rate increase in 2015 and no more until a year later – and stalled in 2019 with the short-term interest rate set in a range between 2.25-2.5%, low by historic standards.
There were still doubts even then. Gov. Lael brainard saw later that the decision to lift rates from zero lower bound to make it more “unwarranted” for many Americans.
With U.S. inflation now at multi-decade highs and more than twice the Fed’s 2% target, some analysts predict they may end up doing something the bank has not done in more than two decades – raise rates by a half a percentage point in one go.
Waller, an inflation hawk, acknowledges that such a move would shock today’s financial markets. They are used to a low rate of interest and low inflation.
Canada and Britain were also affected by policy tightening at the end of 2010s. The Bank of England, however, has committed an additional 15-basis points increase in the last month.
The Bank of Canada raised rates by 0.25% to 1.755% between March 2020 and the end of the global financial crisis. By comparison, rates at the Bank of England rose only 25 basis points.
Andrew Bailey, BoE Governor at one time in November felt the need to declare that “we’re in the price stability industry”, to calm market fears.
All the hesitations of the current generation central bankers regarding turning down borrowing rates could be compounded with a new pressing factor: The huge debt pile created through pandemic-era stimulus programmes.
Global debt reached $226 trillion in 2020. This was the biggest ever increase since World War II. The debt held by governments accounted for record-breaking 99% of world output.
Even a slight move by central banks to increase the cost of borrowing at those levels will have an impact on national treasuries.
Charles Goodhart who was a member of the Bank of England’s Monetary Policy Committee from 1997 to 2000 told Reuters, “It is not so much that (the bankers), will be reluctant, but that their politicians will start making loud noises quick.”
So if they are unhappy it will feed back on you and they will be unhappy.”