It was mid-2013 when Ben Bernanke first suggested the Fed might “taper” down its bond purchases. The Taper Tantrum ensued and stopped him from implementing the policy he clearly thought was right. It fell to Janet Yellen to implement the taper and then make one very tiny rate hike in December 2015. Another tantrum followed, this one centered in China. Plans to raise rates further were again postponed. As I noted in “Mad Hawk Disease” two weeks ago, Fed governors were clearly mindful of what would happen to the then-current Democratic administration if a policy error precipitated a recession. “We couldn’t take the chance.” They ignored Ben Bernanke’s admonition that “The central bank needs to be able to make policy without short-term political concerns.”
Now, with a Republican administration and Congress, the FOMC apparently feels no such concern about the potential for a policy error. We will never know, but I wonder if they would now be raising rates under a Clinton administration. It’s actually a serious question.
Having waited four years too long, the Fed, the ECB, and the Bank of England are finally tightening in a strange combination of caution and boldness. You may have heard public officials talk of being “cautiously optimistic.” The central bank version of that is “cautiously aggressive.” Each passing month makes them less cautious and more aggressive, it seems. Like kittens, they venture out from their mother gingerly at first but soon are romping underfoot and destroying furniture.
Source: Financial Times
That may be an amusing analogy, but reality is not amusing at all. The four largest central banks together have about $13 trillion on their balance sheets, a large portion of which they believe needs to roll off. Removing it without breaking something important will not be easy.
Least-Bad at Best
The central bankers are not unaware of this challenge. They have a conscience of sorts in the Bank of International Settlements, and it is whispering in their ears as loudly as it can. BIS economist Claudio Borio, in the institution’s annual report last month: “The end may come to resemble more closely a financial boom gone wrong, just as the latest recession showed, with a vengeance.”
The report’s monetary policy section was even more direct (emphasis mine):
Policy normalisation presents unprecedented challenges, given the current high debt levels and unusual uncertainty. A strategy of gradualism and transparency has clear benefits but is no panacea, as it may also encourage further risk-taking and slow down the build-up of policymakers’ room for manoeuvre.
That’s obvious, but it’s important that BIS said it. “Unprecedented challenges” may even understate the magnitude of what the Fed and other central banks are up against.
More from BIS: