EN Australia
Macroeconomic & Geopolitical

From Mission Accomplished to Mission Impossible

12 November 2021 - 3 min read

Central banks will be rewarded for their crucial crisis response with more missions that threaten their effectiveness and independence.

If the reward for good work is more work, pity our central bankers.

Following their stunningly successful response to the pandemic lockdowns, the world’s monetary policymakers now face a treacherous collection of challenges with little visibility and limited tools. The risk for markets is that rising political frustration will curb their independence and undermine their effectiveness when the next crises strike.

Confusing price and growth data recently makes it too easy to focus on the risks that current monetary policy is all wrong and forget just how decisively the world’s central bankers intervened last year to avert catastrophe. From Washington and Frankfurt to Moscow and Pretoria, the action was swift and comprehensive

They didn’t get everything right, but one shudders to think of a world that had to await fiscal support from politicians. The responses required a granular analysis of market dysfunction, a differentiated understanding of local conditions, and a careful calibration of intervention, but ultimately they essentially threw a lot of money at the problem and it worked. 

The challenges ahead are far more complex, the disagreements over policy are more intense, and the risks of getting it wrong are much higher.

The immediate test, of course, is the recent surge in prices, including last week’s whopping U.S. Consumer Price Index reading at 6.2%. Central bankers and economists still believe these pressures should unwind next year as the surge in demand normalizes and supplies recover. They know that raising interest rates won’t produce more port capacity or truck drivers—and that patience is a virtue.

Assuming they are right about inflation, the next challenge is deflation. A combination of demographic pressures, globalization, and technology have conspired to drag developed market growth rates lower in recent decades, and it’s not clear that the pandemic reversed this trend. The Fed and the European Central Bank have announced new frameworks that allow inflation to overshoot their 2% targets in the hope of raising the average, but this remains a hope. Negative interest rates could help a little, but their effectiveness may dwindle over time. Of course, the Bank of Japan has little to show for its extensive experimentation to boost growth or prices.

Just this week, the Fed highlighted a third major headache, sharing its concerns about froth and exuberance that threaten financial stability. Given the amount of money that governments have injected to underpin the recovery, the possibilities for unintended consequences are plentiful. In particular, the Fed report cites potential risks from inflated asset prices, rising leverage, and funding risks. Ominously, perhaps, it calls out funding risks to the nascent “stablecoin” sector.

Next on the list is the cost of government debts, which jumped more than 15 percent of GDP in many advanced economies during the pandemic. If central banks need to snuff out inflationary pressures with higher rates, they will be directly adding to the debt costs of their national governments. There are a few immediate concerns about countries tipping into an unsustainable spiral, but politicians will surely start to ask why central banks aren’t doing more to save taxpayers’ money. 

Finally, the very size and effectiveness of central banks has raised calls for more muscular responses to climate change and wealth inequality. But as laudable as these goals may be, the tools don’t necessarily fit the task. As supervisors, central banks can ensure that banks do more to measure and disclose climate risks or even encourage lending in poor neighborhoods, but most of the responsibility on these questions still rests with lawmakers. 

As these challenges grow more complicated, so will the uncomfortable questions for central bankers. Why is a little inflation so bad if it brings jobs to those in desperate need? Do you realize that raising interest rates takes money from worthy government programs? Is there anyone you won’t bail out?

Even if the questions don’t lead to new legal mandates, markets start to provide their own answers. Maybe inflation will begin to run hot so the Fed can argue it’s doing all it can to create jobs for the poor. Maybe rate hikes are delayed because they risk blowing a hole in the budget. Worst of all, uncertainty around its tools for crisis intervention may hamstring central banks’ ability to do what they have demonstrated they can do best.

As General Electric, America’s most storied conglomerate, announces plans to split up its businesses to better focus on sustainable profits, there may be lessons for monetary policy, too. The best way to protect the effectiveness of central banks is to appreciate what they can accomplish, but respect what they can’t.

Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Read More Less

Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).

NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.

21-1919912

X

We use cookies on our website to provide you with the best experience. By proceeding to our site you agree to our Cookies Notice and our site Terms and Conditions.