By Jeanna Smialek, Jack Ewing and Ben Dooley
Central bankers have a favorite mantra: Patch the roof while the sun is shining.
But 10 years after the Federal Reserve worked alongside the European Central Bank and the Bank of Japan to bring the global economy back from the brink, their ability to prevent the next downturn is limited.
Whether the world’s central banks are prepared to combat another slump is becoming less of a hypothetical question as the global economy shows signs of strain. The chances that the United States will enter a recession by next year have grown as manufacturing weakens and trade uncertainty drags on. In Germany, the unemployment rate has ticked higher, and industrial production is slowing. In Japan, weak factory production and waning exports heighten vulnerability.
A recession is far from inevitable — particularly one as deep and painful as the last. But the capacity for the type of decisive response that prevented an even worse outcome in 2008 has been hindered. Back then, central banks cut rates, bought up bonds, extended government backing to financial products, lent money to banks and in some cases coordinated with government authorities to make sure their rescue packages didn’t work at cross-purposes. It was an unprecedented period of experimentation, one that saved economies careening toward collapse.
But today, interest rates remain below zero in Japan and Europe. They are low by historical standards in the United States, leaving less room to cut in a downturn. Most central banks still hold huge amounts of the bonds and other securities they bought to prop up their economies the last time, which could make another buying binge more difficult and dampen its effects.
Global leaders like Christine Lagarde, who was nominated to be the next leader of the European Central Bank, are urging central bankers to act decisively in case of a downturn.
Global leaders like Christine Lagarde, who was nominated to be the next leader of the European Central Bank, are urging central bankers to act decisively in case of a downturn.CreditJim Watson/Agence France-Presse — Getty Images
Monetary policy is also running low on credibility. Major central banks have failed to hit their 2 percent inflation targets during this expansion, heightening the risk that prices will slip dangerously low come the next downturn. And while promises of lower-for-longer interest rates have been a major source of stimulus in recent years, those pledges might lose some of their punch in a world where investors already expect permanently low rates.
Those constraints are especially worrying at a time when governments show little appetite for working together to offset a broad-based global slowdown. The United States and Europe are in the midst of a trade dispute that followed President Trump’s decision to impose tariffs on steel and aluminum and his threat to levy taxes on German and other European cars. Mr. Trump has criticized the European Central Bank for taking steps to protect the eurozone economy, accusing it of trying to weaken the euro and put America at a disadvantage.
Mr. Trump suggested last week that central banks were in something of an arms race, saying on Twitter that China and Europe were manipulating their currencies to gain an edge over the United States and that the Fed should start doing the same.
“We should MATCH, or continue being the dummies who sit back and politely watch as other countries continue to play their games — as they have for many years!” he wrote.
Central bank officials insist that they are prepared to act aggressively if another recession flares. The E.C.B. stands prepared to stimulate the eurozone, and the Fed is signaling that it could soon cut interest rates to try to get ahead of mounting risks in the United States.
But economists across the globe say central banks can no longer be sole saviors the next time a downturn hits. That reality is colliding with political constraints in the United States and Europe, where lawmakers may prove unable — or unwilling — to quickly roll out expensive stimulus packages.
“Fiscal policy has a much more active role to play, and it is not yet equipped to do so,” Olivier Blanchard, a former International Monetary Fund chief economist, said last month at a central banking forum in Sintra, Portugal, specifically referring to Europe.
When it comes to monetary policy, “surely there is not enough room to respond to even a run-of-the-mill recession,” he said.
Christine Lagarde, who has been nominated to succeed Mario Draghi as head of the European Central Bank and currently heads the International Monetary Fund, has warned that central banks are likely to be the main line of defense given fiscal constraints.
“High public debt and low interest rates have left many countries with limited policy room for maneuver,” Ms. Lagarde said in a June blog post. She added that in a downturn, nations would need to use their economic tools together, with “decisive monetary easing and fiscal stimulus wherever possible.”
Global economic growth has crept back after a deep recession, and as recently as early 2018 a coordinated international expansion was underway. But progress has shown cracks in recent months, with trade flows slumping and manufacturing indexes pulling back from Asia to Europe.
The Morgan Stanley economist Chetan Ahya estimates that if Mr. Trump’s trade war with China isn’t resolved and the administration follows through with its threats to increase tariffs, growth could fall enough that “we could wind up in a global recession in about three quarters.” Risks seem to have abated slightly after the recent Group of 20 meeting, where Mr. Trump suspended a tariff escalation and restarted trade talks with China.
But uncertainties persist. Those talks could crumble again, leading to additional import taxes. And beyond America’s trade wars, the threat of a disorderly British withdrawal from the European Union and a continuing slowdown in China pose further risks to international activity.
Those factors prompted Mr. Draghi to strongly signal in June that the central bank was planning to revive stimulus measures it had used during the eurozone debt crisis.
While Mr. Draghi insisted the bank still had “considerable headroom” to buy bonds as a way of pumping money into the economy, some analysts think he acted pre-emptively precisely because he knows the central bank’s capacity is finite. Better to use the bank’s limited resources now when they can still do some good.
In the United States, the Fed is also considering acting sooner rather than later as it tries to judge whether a rate cut is warranted. Emerging research suggests that moving quickly and decisively might be the central bank’s best defense.
While the Fed is in comparatively good shape because it has gotten rates off rock bottom — they’re at 2.25 to 2.5 percent — that leaves it just half as much room to cut borrowing costs as policymakers had back in 2007. In fact, the Fed’s chair, Jerome H. Powell, has started a yearlong review of just what its options are.
“Having low interest rates really challenges the existing tool kits of central banks,” Mr. Powell said during remarks in New York last month.
Fed officials say they are prepared to revive large-scale bond-buying programs to stoke economic activity when the next downturn comes. The central bank is also contemplating new policy approaches that would leave rates lower for a longer period after a downturn. Recent research suggests such policies would have had benefits — though in some cases small ones — if applied after the 2008 recession.
Japan offers a cautionary example that mere willingness to act doesn’t guarantee success. Haruhiko Kuroda, head of the Bank of Japan, has pulled out all stops to reignite the country’s economy, cutting rates into negative territory and buying government debt and stocks in a bid to bolster markets and stoke confidence. The government has helped, spending readily to stimulate demand.
Despite all of that effort, inflation remains mired below Japan’s target, which is bad news since it increases the risk of outright deflation should growth weaken.
It is now unclear how much room Mr. Kuroda has for action should a deep downturn come, according to Makoto Hara, the author of a recent book on Japan’s central bank.
“Those taboo policies have become normal,” he said. “They’ve continued them until they became numb to them.”
Central banks in major economies are in their diminished positions largely because sustainable growth, inflation and interest rates have all fallen, trends that are attributable to long-running structural forces in the economy including aging populations and weakening productivity.
In the United States, the nonpartisan Congressional Budget Office sees gross domestic product increases leveling off near 2 percent. The International Monetary Fund estimates that output could drift lower in emerging markets and advanced economies alike.
That has coincided with fiscal restraint across the globe, as governments try to rein in spending and avoid further bloating debt levels.
American politicians restrained government spending after the 2008 recession, even when unemployment remained high and growth was tepid.
Recent tax cuts and spending increases, ushered in by Republican lawmakers, have increased the federal debt, but there does not appear to be a broader embrace of deficit spending underway, particularly as the 2020 presidential election approaches.
America’s budget deficit is on track to surpass $1 trillion this year, and some lawmakers are already looking for ways to cut, not add to, federal spending.
Central bank leaders have increasingly warned that their firepower will be limited without help from fiscal authorities.
“Monetary policy will continue to do its job no matter what happens to fiscal capacity,” Mr. Draghi said, just a few days after European leaders largely failed to set up a mechanism to jointly provide stimulus when needed. But aid from governments “would do the same job faster and with less side effects.”
Mr. Powell echoed that sentiment last month. “It’s not good to have monetary policy be the main game in town, let alone the only game in town,” he said.