Since the global financial crisis, central banks have added trillions to balance sheets, and many markets have recovered. Now a major question lingers for central bankers, policy-makers and investors about balancing the effects of higher interest rates and tighter monetary policy.
“We are in pretty unchartered territory. Exiting from QE [quantitative easing] will be a difficult exercise,” said Axel A. Weber, Chairman of the Board of Directors, UBS, Switzerland.
“QE has been a resounding success in the US, EU, Sweden, everywhere. It’s the strongest recovery for past 20 years,” said Benoît Coeuré, Member of the Executive Board, European Central Bank, Frankfurt. But the recovery has raised a key question for some central bankers: “How can it be that we’ve injected so much money into the system, and inflation is still weak?” Coeuré asked.
Central bankers focus heavily on inflation rates; however, some economists believe that the meaning of inflation is changing due to fundamental shifts in the markets. Namely, technology has changed the way people live, work and consume.
“Do we really understand what inflation means today?” asked Min Zhu, Chairman, National Institute of Financial Research, People’s Republic of China. Zhu cited e-commerce, artificial intelligence and automation as some of the factors that raise questions about the relationship between inflation and growth.
Low inflation rates are also linked to the low-wage growth that much of the developed world is experiencing. Despite billions of dollars created by central banks in quantitative easing, average wages for most workers have not increased significantly.
“As an employee, you will ask for a higher salary when you have the opportunity to do it,” said Cecilia Skingsley, Deputy Governor, Swedish Central Bank (Sveriges Riksbank). Skingsley noted that changing models of employment – such as the “gig economy”, which offers flexible work options but little income certainty – have left many employees without job security and thus poorly equipped to advocate for higher wages.
While the era of easy money has powered increases in GDP and equity markets, some experts see signs of a future downturn. On the one-year horizon, tax cuts in the United States are likely to stimulate growth, and low interest rates and high government spending in both the US and the EuroZone suggest that markets will continue to prosper. However, some suggest the trajectory is unsustainable.
“We’re at a limited amount of capacity and a lot of stimulation,” said Ray Dalio, Founder, Chairman and Co-Chief Investment Officer, Bridgewater Associates, USA, citing the recent US tax cuts. “There needs to be some kind of tightening.”
With that tightening, some experts see the possibility of downturn on the two- to three-year horizon. For central bankers, investors and policy-makers, a question could be how to soften the landing and find alternative ways to boost wages and find new forms of growth.
Another question on the horizon for monetary policy-makers is the future of the dollar as the global reserve currency. This week, markets experienced confusion about the US commitment to maintaining a strong dollar, and this confusion has generated a conversation about whether the dollar’s role will shift in the future. Some investors see diversification into non-dollar assets as more likely, while others suggest the recent confusion was an aberration and that, in an era of uncertainty, the dollar will continue to play its traditional role given its stability and liquidity.