But one of the other key points to emerge is in its chapter on the “limits of monetary policy”. There is, it appears, a marked admission that central banks may be losing control.
We don’t mean that in the old cynical sense we’ve heard before — that because central banks are zero-bound they are running out of tools — we mean it existentially.
What’s more, the theme is growing in official circles.
Pimco’s Mohammed El-Erian was the most recent high profile name to throw light on the issue. Commenting on the Fed’s latest decision to extend Operation Twist last week, El-Erian explicitly stated that lacking fiscal support, solitary Fed activism would only alter the functioning of markets, contaminate price discovery and distort capital allocation.
The hint was very clear. Markets should stop calling for QE3, because QE3 would probably do more harm than good at this point:
Already, the viability of several segments – from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined. The Fed has also conditioned many market participants to believe in a policy put for both equities and bonds. And other government agencies are relieved to have the policy spotlight remain away from their damaging inactivity.
The Fed feels compelled to act in some way (i.e. extending Operation Twist) rather than doing nothing because it knows political brinkmanship binds the hands of the Treasury and its ability to apply the correct course of action. That course of action is very aruably extending the debt ceiling, the only possible move which may be able to overcome the issues faced by the Fed today. Bernanke has hinted as much already.
In that context markets should really be calling for Treasury action, not Fed action.
While the BIS report echoes the point that accommodative policy is no longer enough, it ironically advises that governments should become mindful about fiscal sustainability rather than, in the very specific case of the US, look beyond perceived constraints and actively go about creating more safe assets:
First, prolonged unusually accommodative monetary conditions mask underlying balance sheet problems and reduce incentives to address them head-on. Necessary fiscal consolidation and structural reform to restore fiscal sustainability could be delayed. Indeed, as discussed in more detail in Chapter V, more determined action by sovereigns is needed to restore their risk-free status, which is essential for both macroeconomic and financial stability in the longer term.
Nevertheless, it’s the BIS view of what’s happening in the money markets which arguably offers the real tell-tale signs of a central banking crisis in the making:
Furthermore, there is evidence that the dynamics of overnight rates are changing. In the United States, the pass-through from the unsecured overnight rate to secured rates – a crucial link in the transmission of the monetary policy – has weakened during the period of near zero rates. In Sweden, the volatility of the overnight rate (tomorrow-next) has been higher than before the crisis since the Riksbank’s exit from its balance sheet policies.
With a view to controlling the overnight rate in an exit scenario, central banks need to have in place properly tested tools for controlling reserves. Moreover, they may need to reconsider whether the precrisis practice of targeting a short-term unsecured market rate is still the most effective.
The latter observation — about central bank targets — has interestingly already been raised by Elizabeth Klee and Viktors Stebunovs from the Federal Reserve Board in a paper published in September 2011. The paper argued very credibly that central banks should shift towards targetting repo rates instead of unsecured lending rates.
As to the effectiveness of national central banks more generally, the BIS notes:
The growing relevance of monetary policy spillovers suggests that central banks need to take better account of the global implications of their actions. In a highly globalised world, a more global monetary policy perspective is also called for to ensure lasting price and financial stability.
A strong hint that the BIS feels a global central bank may be the only cure to the malaise currently afflicting the multiple national central bank system.
But then the BIS, being the central bank to the central banks, probably would say that…
A central bank is only as good as its target – FT Alphaville
Eurozone as a tragedy of the commons – FT Alphaville
A target Treasury general collateral repo rate: Is a target repo rate a viable alternative to the target federal funds rate? – FRB
The cost of global central bank balance sheet expansion – FT Alphaville
On the perils of plunging repo rates – FT Alphaville
Are western central banks having an existential crisis? – FT Alphaville