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To say that it has been a wildly volatile year for financial markets would be an understatement … and we are only in mid-February! Indeed, it has been quite a while since we have seen such intra-day fluctuations — up and down — in stocks, bonds, and oil.
Unsurprisingly, this volatility has unsettled many investors, contributing to growing financial insecurity. If it continues, it would also risk aggravating economic insecurity, undermining growth potential and fueling political debates.
All this serves to place an even brighter spotlight on central banks — from the Federal Reserve and the European Central Bank to the Bank of Japan, the People’s Bank of China and others. For example:
- Some observers argue — wrongly in my opinion — that the volatility in financial markets is the result of the Federal Reserve’s decision in December to raise interest rates by 0.25%;
- Some — and, I suspect, way too optimistically in my opinion — think that central banks can just push a policy button in order to restore market calm in a durable fashion; and
- Too many politicians around the world have delegated economic governance to central banks that only have partial tools to tackle the consequential challenges facing the global economy.
With all this going on, I thought you may be interested in an excerpt from my new book, The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.
Appearing on page 253, this book extract summarizes the role of central banks in the aftermath of the global financial crisis that violently erupted in 2008. It highlights the extent to which these institutions have been the primary policymaker in many countries; and points to what they can and cannot do going forward.
Central bank activism did not stop with their success in normalizing utterly dysfunctional markets and calming a financial crisis that had brought the global economy to a virtual standstill. Having succeeded, they then found no one to hand off to for the next stage of the economic recovery. As such, they felt that they had no choice but to take on unprecedentedly large responsibilities for the macroeconomy.
This was not a power grab. Nor was it something that central banks were seeking. Instead, with political dysfunction paralyzing other policymakers with better policy tools, central banks felt a moral and ethical obligation to do whatever they could to buy time for the private sector to heal and for the political system to get its act together and assume its economic governance responsibilities
In this new role, central banks did more than assume a leadership role. They also supplied almost the entire content of the policy response, and did so with inherently partial and blunt measures.
Being the only game in town, central banks found themselves pushed ever deeper in experimental policy terrain, and they have stayed there much longer than anyone anticipated or may have hoped for initially.
Policy making often entails difficult trade-offs. This phase of modern central banking has been no different, though with one major qualification: This time around, central banks have not been able to resort to reliable insights and information from historical precedents, analytical models, or past policy experience. There are none that can guide them properly and inspire well-placed confidence.
On the positive side, the central banks’ unconventional measures did manage to buy considerable time and space for others to get their act together. They facilitated major private sector balance sheet repair, starting with banks and then corporations and households. They contributed to growth, albeit frustratingly tepid, and, in the case of the United States, to significant job creation.
Like dedicated engineers, central banks constructed the best bridge possible with the limited materials they possessed. But no matter how long a bridge they have built, the right destination was never theirs to deliver on their own.
Excerpt from the New York Times best seller released on January 26th, 2016: The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse, published by Random House. (www.mohamedel-erian.com)
Mohamed A. El-Erian is Chief Economic Advisor at Allianz, the parent company of PIMCO where he served as CEO and co-CIO (2007-2014). He is Chair of President Obama’s Global Development Council, a Bloomberg View columnist, and aFinancial Times contributor. His first book, When Markets Collide — also a New York Times best seller — was named a book of the year by the Economist and a best book of all time by The Independent, as well as winning the Financial Times/Goldman Sachs award for Best Business Book of the Year.
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