Could it be that we have too much faith in central bankers?
In a week in which U.S. Federal Reserve Chair Janet Yellen reveals all to Congress, Bank of Canada governor Stephen Poloz exposes his latest monetary policy and Bank of England's Mark Carney warns that British property prices pose the "biggest risk" to the U.K. economy, perhaps we have begun to overestimate the power of our central bankers.
For many years, we seemed to think they were economic magicians. Perhaps that perception was influenced by that larger-than-life gunslinger, Alan Greenspan. When he was Fed chairman, Greenspan spoke with supreme confidence and always seemed to have the right answer.
Interestingly, Yellen and Poloz, with their more hesitant personalities, help reveal a concealed truth about monetary authorities. Especially at this stage of the economic cycle, central banks have far less power to fix the global economy than many people, including U.S. senators, seem to give them credit for.
We will be reminded of that today, when Poloz offers his monetary policy report, but Yellen's performance before a Senate committee yesterday set the tone.
From the demographic decline in the labour force to depressed U.S. housing to weak job creation in poorer U.S. states, Yellen confessed she was unable to solve the economic problems the senators posed.
People without perfect credit scores can't borrow. Fiscal spending is on hold. The long-term unemployed suffer debilitating psychological damage. Citizens have a depressed outlook about their personal future. Central bankers can do nothing about those things.
On all those points, Yellen repeatedly admitted that central bankers, at this stage at least, are observers and reactors rather than movers and shakers, waiting to slow the economy if it shows too much life.
Greenspan a gunslinger
How different was Greenspan. In his brazen manner, he always had a trick to solve any economic problem. A crisis at Long-Term Capital Management? Falling tech stocks? No trouble. Of course, he used the same trick over and over again. Cut interest rates. And cut them again. And it worked. Well, it worked up until the U.S. housing market collapsed and the banks started to crumble.
If there were another major credit crunch now — caused by, say, a collapse in overheated markets and assets — well, Yellen's cupboard is bare. U.S. interest rates are already as low as they can go. Instead, the central bank has bought, and holds on its balance sheet, trillions of dollars in bank debt and government bonds.
Just as Poloz will tell us today, Yellen gently disclosed to senators that monetary tools are a blunt instrument. Even in the places where central banks have theoretical power, they are, as one senator astutely observed, "in a trap."
One of my repeated complaints has been that low rates merely push up asset prices, essentially robbing the poor and making the rich richer.
Yellen does not disagree. In response to senators' concerns about a potential stock bubble, Yellen began to sound like the French author Thomas Piketty. U.S. economic returns, she said, were moving "away from labour to capital."
But can she do anything about it? Not really. While raising rates to counter this effect might be possible, it is "by no means costless," she said. In a central banker's balancing act between a strong, job-creating economy and a potential asset bubble, Yellen observed that raising rates to crush a future bubble or slow the flow of returns from labour to capital would likely also mean a decline in jobs.
This is exactly the problem that Poloz and Carney have in their own overheated property markets. British house prices are up 10 per cent; London itself is up 20 per cent. Canadian price rises released yesterday are not as hot but still a worry, up seven percent. But for the same reasons as Yellen, these supposedly powerful central bankers find their hands tied.
When Carney was Canada's central banker, his main role was to be defiant and debonair while riding the wave of the former Liberal government's balanced budget. But he repeatedly showed his power in a different way, using not the hammer of interest rate changes, but the moral suasion of his public utterances to do things like talk down the Canadian dollar.
Poloz isn't as cool as his predecessor, but Citigroup recently declared that when he expresses his views about his currency, the world listens.
Yellen's biggest impact yesterday also came from mere words. Her warning that the price of small biotech and social media stocks may be “substantially stretched” sent shares in those sectors tumbling. For example, social media company MeetMe ("a place to chat and meet new people") fell nearly five percent.
Later today, Stephen Poloz is almost sure to announce that he will keep interest rates at one per cent. But there is one rope that ties his hands that doesn't tie Yellen's. That rope is Yellen herself. It is very difficult for a Canadian bank governor to fight the Fed.
On the other hand, even if he doesn't actually do anything today, it always pays to listen carefully to what a central banker says.