New tools for central bankers?

• Position: A SYMPOSIUM OF VIEWS

Central banks worldwide face criticism for the inability' of their policies to restore the global economy to historic levels of economic activity. Central bank bond buying, it is often charged, has distorted financial markets. Negative real interest rates have weakened many banking sectors.

At this summer's Jackson Hole meeting, Federal Reserve Chair Janet Yellen proclaimed: "New policy tools, which helped the Federal Reserve respond to the financial crisis and Great Recession, are likely to remain useful in dealing with future downturns. Additional tools may be needed." What new tools should the central bank community' consider? Or has monetary policy been perceived too much as some kind of magical pill? Should fiscal and regulatory reforms come into play?

More than forty noted experts share their views.

The answer is not to push central banks even deeper into what has become an increasingly "lose-lose" situation.

MOHAMED A. EL-ERIAN

Chief Economic Advisor, Allianz; Chair, President Obama's Global Development Council; and author, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse (Random House, 2016)

Reinhold Niebuhr's "Serenity Prayer" makes an important distinction between having the courage to change the things that can be changed and the serenity to accept what cannot be changed. It also seeks the wisdom to know the difference. As such, it provides important insights for assessing the need and potential effectiveness of new tools for central banks.

By necessity rather than choice, and for too long already, central banks have been carrying an excessive policy burden. With tools only poorly suited to fix what ails advanced economies, they have found themselves compelled to experiment ever more despite outcomes that have consistently fallen short of their own policy expectations.

Given such protracted over-reliance on imperfect tools, it should come as no surprise that the benefits of such an unbalanced policy stance--with central banks effectively being "the only game in town" policy-wise--are declining while the risks of collateral damage and unintended consequences are rising.

As tempting as this may be, the answer is not to push central banks even deeper into what has become an increasingly "lose-lose" situation--"lose" for economies that already lack high and inclusive growth, and "lose" for central banks whose reputation and political autonomy are under increasing strain.

The right answer is to urgently broaden the policy response to include measures that can lift the binding constraints to prosperity--through pro-growth structural reforms such as tax system revamps, infrastructure programs, and labor market retooling; more active use of fiscal policy, especially where there is clearly scope and debt room; addressing pockets of crushing indebtedness; and improving cross-border policy coordination and the economic architecture, especially in Europe.

This does not mean that central banks should exit the policy stage. Rather, the time has come for them to transition ... from the lead role in what essentially has been the equivalent of a "one-person show," to playing a supporting role to politicians that finally step up to their economic governance responsibility and lift the constraints to a more comprehensive policy response.

Absent such a pivot, the quest for new tools for central banks may be associated with a much more disturbing and durable development--that of seeing central banks shift from being part of the solution to becoming part of the problem. And, certainly, this would not be in the interest of a global economy that, already, has operated well below its potential for too long.

Take more targeted actions.

BENJAMIN M. FRIEDMAN

William Joseph Maier Professor of Political Economy, Harvard University

Since the 2007-2009 financial crisis, with short-term interest rates at or near zero, central banks have had varying degrees of success in lowering long-term rates by large-scale bond purchases, including in some cases purchases of privately issued securities (in the case of the Federal Reserve System, residential mortgages). But there is nothing about the way this action works that is special to a situation of zero short-term rates. Once central banks have "normalized" their policy interest rates, they should continue to entertain the possibility of using this new tool of monetary policy. Moreover, they should be prepared to use it symmetrically--that is, not just buying bonds when their goal is to lower long-term rates in order to stimulate the economy, but selling when higher long-term rates are desirable.

Such actions would also give central banks the ability to take more targeted actions. During the run-up to the crisis, Federal Reserve officials were right that raising short-term rates would have been a "blunt instrument" with which to attack even an obvious excess in one sector of the economy (in this case, home construction) or one specific market (mortgages). By contrast, selling mortgage-backed securities would have usefully widened the spread between Treasury rates and mortgage lending rates. No one knows what needs of this kind may arise in the future.

A further implication of this proposal is that central banks should not "normalize" their balance sheets--in other words, shrink back to pre-crisis size--as they normalize their policy rates. They cannot sell securities that they do not own. Maintaining a symmetrical bond purchase/sale capability, as an additional monetary policy tool, requires having a sizeable portfolio to begin with. Most central banks now do. They should maintain it.

Monetary policy cannot fix real problems.

ALLAN H. MELTZER

Allan H. Meltzer Professor of Political Economy, Tepper School of Business, Carnegie Mellon University, and Distinguished Visiting Fellow, Hoover Institution

The problem is not that policy tools have failed. The problem is that the developed countries do not have a monetary problem--a problem that central banks can relieve by reducing interest rates and increasing base money.

The United States, the European Union, and Japan have severe real problems. A first principle of economics separates real and monetary problems. Monetary policy cannot fix real problems.

The Obama Administration does not give priority to economic growth. It concentrates on redistribution toward its supporters. It regulates frequently and heavily, creating uncertainty. That's a main reason for the virtual absence of any new private capital spending in the recovery. Without investment, workers do not learn new skills, so productivity growth is reduced. These are real problems. The fact that almost all the reserves that the Federal Reserve supplied from 2009 to the present are idle shows that the Federal Reserve was wrong to keep adding to idle reserves. Instead of adding more excess reserves and financing the huge budget deficits at very low rates, it should have made the government pay for its spending.

The European Central Bank has a different real problem. Unions in France and Italy are strong politically. Production costs in both countries are uncompetitive. Unions prevent the parliaments from taking actions to lower unit labor costs. Germany, Netherlands, Spain, and Ireland made the cost adjustment. France and Italy, the second- and third-largest countries economically in the European Union, make the Union noncompetitive. Mr. Draghi is mistaken if he believes his central bank actions will bring economic expansion. The problem is real.

I served as honorary adviser to the Bank of Japan until 2000. Even then economists and officials understood that Japan's problems required more competitive labor and commodity markets. That hasn't changed in almost two decades. But it is now accepted by the Abe government.

Economics has not failed. Central bankers have.

The Fed will resort to its one tool, not because it's a good idea but to show that it can. Interest rates will rise.

JAMES K. GALBRAITH

Lloyd M. Bentsen, Jr., Chair in Government/Business Relations and Professor of Government, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin

The mainstream economists have staggered, like drunks at midnight, from one monetary light-post to the next. Not long ago, money was "neutral"-- affecting nothing save inflation. Then after the Great Financial Crisis, quantitative easing was--it was suggested--if not omnipotent, at least a powerful new tool for growth and jobs. Now, the disappointing results are in, and we hear that a central bank is impotent after all. Even getting to a bit more inflation, by mainstream lights the one thing monetary policy could do, seems out of reach.

In truth the Federal Reserve controls the short-term interest rate, which is the cost of funds to banks. It has discovered what is no surprise to any Keynesian, that lowering the short rate, even to zero, has only small effects on household cash flow and none to speak of on business investment; if households and businesses do not wish to borrow a low interest rate does not help.

But if you keep the short rate low for a long time, the long-term rate follows it down. And once that has happened, you're stuck. A move to raise the short-rate then flattens or inverts the yield curve, and hell breaks loose, somewhere in the world.

So the options narrow. And what the Fed has done is to resort to the art of heavy hints and dark warnings. Much is said, but nothing happens, a Talmudic obscurity descends, an industrial analysis of syntax, grammar, punctuation and facial tics. The great accountability reforms of H.Con.Res.133 in 1975 and the Humphrey-Hawkins Act in 1978, which gave us forty years of monetary policy hearings, meet at last the principle of diminishing returns. And we can understand why, under a Democratic president, good liberals are shunted to the central bank. It's because they are less trouble there than they might be somewhere else.

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