JEDDAH – Central banks, if they are to avoid an excessive concentration of risks, need to find a way of nudging other policymakers into action, Dr. Jarmo T. Kotilaine, Chief Economist, The National Commercial Bank, Jeddah, said Wednesday.
As the Bank for International Settlements (BIS) recently noted, the current situation is one where "Central banks are being cornered into prolonging monetary stimulus, as governments drag their feet and adjustment is delayed. It would be a mistake to think that central bankers can use their balance sheets to solve every economic and financial problem."
In Europe, this will likely have to mean genuine steps toward an EU-wide bank regulator and a fiscal union, Kotilaine said.
Commenting on the ongoing eurozone debt crisis, he said "in the meantime, the real risk with the gradualist paradigm is that policymakers risk being overtaken by events.
A period of market panic would call for immediate action which is subject to the relevant regulations being available, even if the room for innovation is not completely nil. One option that likely merits greater attention that it is currently getting is a more flexible target-based monetary policy, for instance open-ended quantitative easing linked to particular macroeconomic objectives.
Such instruments could be reactivated when the data calls for it as opposed to being entirely based on the discretion of policy makers or regulatory innovation."
Commenting on "Operation Twist" – a US Federal Reserve monetary policy operation that involves the purchase and sale of bonds. "Operation Twist" describes a monetary process where the Fed buys and sells short-term and long-term bonds in an attempt to lower long-term interest rates, Kotilaine said "the extent to which it has met its key objective of lowering long-term interest rates remains in dispute.
In practice, however, long-term rates are low (due to a whole host of factors), further underpinned by the clear commitment to very loose monetary policy that Twist represents. The Fed has signaled that short-term rates are now unlikely to budge before 2014."
He said the Fed decision reflects more generally the "curious conundrum" of central banking at the moment. The general bias is toward greater loosening but at a very measured base. The UK recently launched the Extended Collateral Term Repo Facility and further quantitative easing is seen as likely.
Moreover, the European Central Bank seems in principle ready to reduce rates below the current 1 percent and has already broadened the range of securities it accepts as collateral for loans. These now include asset-backed securities based on car loans, consumer credit, corporate loans, and residential mortgages with haircuts applied to riskier instruments.
The relative caution contrasts with a deteriorating outlook for the global economy along with an unusually disturbing risk profile.
He argued that part of the caution is clearly linked to the fact that central banks are being asked to do a lot. "Yet by doing more, central banks are assuming greater risks, which may not be prudent policy in the face of the current uncertainties," Kotilaine said. – SG