The next global economic downturn will require the world’s largest central banks to consider new policy options, according to new analysis published by Insight Investment (Insight).
The paper is titled “Policy Options in the Next Downturn” and is authored by Isobel Lee, lead author of research and head of global fixed income bonds at Insight.
She assessed the policy actions of five major central banks - Federal Reserve, People’s Bank of China, Bank of England (BoE), European Central Bank (ECB) and Bank of Japan (BoJ) since the financial crisis in 2008 and concludes that collectively institutions would need to think more imaginatively in the future.
Ms Lee outlines five potential alternative options that policy makers may turn to address future economic downturns that could be characterised by ongoing economic issues such as low interest rates and low inflation. The options included in the report are: alternative inflation targets, modern monetary theory, offsetting negative interest rates, macroprudential policy and yield curve control.
The report offers a mixed picture the majority of these policies, perhaps offering the most positive outlook on macroprudential policies.
Ms Lee cites both Australia and Canada as examples where such polies could be implemented on property. Australia and Canada have used macroprudential policies to cool house price inflation, reducing pressure for interest rate hikes which would have had a broader economic impact. This has included tax surcharges on foreign buyers, limits on interest-only loans and the introduction of stress tests to limit lending. She believes these policies have proved highly effective in Canada and “were instrumental in allowing the central bank to shift from a hiking bias to neutral in the first half of 2019”.
Commenting on her report, Ms Lee said: “With interest rates at such low levels, and central banks already owning a substantial part of bond markets, the policy tools used after the global financial crisis may not be sufficient in the event of a new economic downturn. This may leave central banks and politicians looking for alternative policy options.”
She also suggested that China and the US appear to have more opportunities to be flexible with policies than the ECB or BoJ, who appear to be the most limited in terms of future policy options.
Ms Lee also made a comparison between the Bank of England (BoE) and the ECB, and suggested that the UK could be in a more advantageous position.
She said: “Despite political turmoil surrounding Brexit, the BoE does at least have some flexibility to act to stimulate growth if necessary. This leaves the BoE in a better position than the ECB, which may be close to exhausting its available policy options and is legislatively restricted from more radical policies such as monetised fiscal expansion. If the global economic slowdown becomes more pronounced, it is difficult to see what the ECB or BoJ could do that would meaningfully counter a new downturn.”
