The Federal Reserve has halted policy normalisation. Now, other central banks should follow suit

The Fed’s decision to stop interest rate rises and the shrinking of its balance sheet this year should be a cue for central banks in Europe, Japan and particularly China to take steps to bolster economic activity

David Brown

Published: 2:57pm, 25 Mar 2019

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World markets are taking a turn for the worse and crying out for central banks to adjust policies to stop the rot. Global manufacturing has taken a dive, stock market confidence is on the ropes and the US Treasury yield curve is firing early warning shots about a possible future recession. It is not panic stations yet, but the US Federal Reserve seems ready for action. The Fed cannot succeed in isolation and needs other central banks to join forces to stop a deeper crisis unfolding. The worry is whether there is enough left in monetary reserves to turn the tide.

At least the Fed seems to have the situation covered for now. Last week’s US monetary policy meeting marked a turning point, with the Fed intimating that, despite strong past performance, US growth could be vulnerable and policy should change tack to forestall a steeper slowdown. There will be no more US interest rate tightening this year and cutting back the Fed’s balance sheet will end sooner than planned. Putting policy normalisation on hold is a bold move and should be a positive step for global recovery prospects and world markets.

The Fed may be shying away from the suggestion of lower rates just yet, but that option should not be ruled out if the outlook deteriorates any further. The 2008 crash taught the Fed some hard home truths and it is now showing better readiness to proceed with a new monetary approach. The old dogma, worrying about overegging growth and inflation risks, has given way to a new thinking – global recovery is under par, deflation risks persist and super-stimulus should stay intact for longer than anticipated.

The Fed is acting out of caution rather than fear and it holds important lessons for other central banks, especially for China, Europe and Japan. The world changed inexorably after the 2008 crisis, paving the way for a new order of altered economic priorities and more effective policy remedies. There should still be plenty of scope for central banks to intercede before any future storm hits.

But 10 years after the crash, central banks still need to think outside the box. For Beijing to have any chance of meeting its 6 to 6.5 per cent growth target this year, the People’s Bank of China must step up measures to reflate confidence and bolster economic activity. Inflation is too low and money supply growth too sluggish – both signs of an economy working below capacity and in need of extra support to boost recovery.

Beijing orders banks to relax bad debt ratio on credit to small companies

Beijing must loosen its monetary reins even more and extend policy accommodation as much as possible throughout the economy. It may go against the grain of conventional wisdom but easier access to cheaper credit is still needed for consumers, businesses and new enterprise.

Interest rates should be cut, bank reserve ratio requirements loosened and faster domestic credit expansion encouraged in every way possible. Structural constraints on borrowing are inconsistent with an economy aiming for faster recovery. The current 6.5 per cent inflation-adjusted annual rate of growth of M2, the broadest measure of money supply, is too low by historical standards and needs accelerating.

Exceptional measures are required universally as the world struggles to regain its footing in the wake of the global financial crisis. The US-China trade war, the world trade slowdown, the Brexit crisis and Europe’s populist threat are not the causes of the global slowdown, but symptoms of a post-crash economic disorder which are still taking their toll. Taking back control and defending national interests are not the answer to boosting global recovery. But central banks working together to revitalise economic confidence is a better step in the right direction.

Austerity programmes must be reversed while central banks should resist normalising policy for as long as possible. It is something the Fed has taken on board and which the European Central Bank is also considering. Central banks should lean with the wind, restore economic confidence and encourage financial market exuberance as much as possible.

Global recession and a stock market meltdown are preventable, but central banks must step up their efforts to make the world a stronger place.

David Brown is chief executive of New View Economics

This article appeared in the South China Morning Post print edition as: Fed has spoken, and now other central banks need to follow

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