Central-bank support first saved the global economy, but then encouraged bad behaviour
What changed in the last 20 years?
Central banks steered the global economy through periods of major upheaval – the dot-com bubble, the financial crisis, the euro-zone crisis – by driving down interest rates and pumping greater levels of stimulus into the financial system. Central banks have maintained this “loose” monetary policy even though economic growth has re-emerged, albeit at a low and slow level. But maybe of more concern, policymakers haven’t been able to create enough inflation globally even though prices have soared for equities, real estate and other asset classes. The markets are now all but “addicted” to central-bank support.
What could the future hold?
Central bankers feel they have no choice but to keep rates ultra-low or even negative, even though this doesn’t leave them much room for manoeuvre when the next recession or crisis hits. They may need to resort to more unconventional tools, such as adjusting their inflation targets or underwriting large increases in government spending. Moreover, politicians still need to fix the underlying structural issues in economies, including low productivity growth, businesses making bad investment choices and steadily rising overall debt levels.
Why does it matter for investors?
Too much monetary stimulus can jeopardise financial stability. When rates are low, risk-taking and debt levels rise, which can cause credit and asset bubbles. And when the economy eventually slows down, companies struggle to maintain their debt burdens and are run for cash – which raises the risk of defaults, lowers investment and can even reduce employment. If central banks can’t fix some of the economy’s deeper problems, governments may resort to fiscal stimulus in the form of increased spending or tax cuts. Central banks may be pressured to finance these initiatives by buying up more debt, raising the spectre of sovereign default if governments are unable to fulfil their obligations.