“There is no inflation, so the central banks ask the fiscal authority to spend more to support aggregate demand,” Praet said on an Oct. 15 panel discussion hosted by the Institute of International Finance. “But when their interests start to diverge, that’s a very delicate moment.”
Former Fed Governor Randall Kroszner agreed. The big debts that governments are racking up are “going to make it difficult for central banks to raise rates when they feel the need to do so” because that will increase borrowing costs, he said on the same panel as Praet.
The Fed will also find it politically hard to trim its huge balance sheet after Congress effectively authorized an increase by allocating money to the Treasury to set up emergency lending facilities with the U.S. central bank, said Kroszner, now a University of Chicago professor.
The debt deluge may have other consequences. The Treasury market is now so large that that it may not be able to function smoothly on its own during times of stress, according to Fed Vice Chair for Supervision Randal Quarles.
He told a virtual discussion organized by the Hoover Institution on Oct. 14 that it was an “open question” whether the Fed would have to keep buying Treasuries to aid the working of the market. The central bank is currently purchasing about $80 billion of Treasuries a month.
Quarles clarified those remarks the next day, telling the IIF that he didn’t mean to suggest that he saw a need for a permanent Fed backstop of the Treasury market.
Randal Quarles, vice chairman of supervision at the U.S. Federal Reserve, speaks during the American Bar Association Banking Law Committee annual meeting in Washington, D.C., U.S., on Friday, Jan. 17, 2020. The Federal Reserve is shifting its focus from writing and revising rules aimed at limiting risk in the banking system to a concentration on how lenders interpret the restrictions, Quarles said.
Central bank leaders from Europe, Japan and the U.K. stressed the importance of maintaining the independence of their institutions at a virtual international banking seminar on Sunday.
“We have to steer clear of what would be regarded in popular parlance as fiscal dominance,” European Central Bank President Christine Lagarde said.
Andrew Bailey, governor of the Bank of England, said the independence of central banks hasn’t been eroded by their coordination with governments to help economies through the coronavirus crisis this year.
The bond market is underestimating how strongly the U.S. economy will rebound, and that may lead to a “mini taper tantrum” next year, according to John Herrmann at MUFG Securities Americas. In the 2013 taper tantrum, yields surged after the Fed suggested it would begin scaling back its bond purchases.