Episode 19: Pow! Pow! El-Erian Talks Central Bank Ammunition

Bloomberg View columnist. He's chair of President Obama's Global Development Council, he's chief economic advisor at Alliance, and he's also a prolific writer. I'm pretty sure he writes more than full time journalists, which is pretty anyway. That's right, and he also has a new book out which feeds directly into what we're actually going to talk about today. That's right. Today going to be talking about central banks and the extraordinary influence they wielded not just on markets but on

the economic life of nations since the financial crisis. The secondary question is whether they are running out of ammunition, whether their influence is diminishing, or as a colleague of ours has put it, whether they've become impotent. And on that note, it's a really good time to talk about it, because just last week we had the European Central Bank announced a whole raft of new stimulus measures, and we didn't necessarily see the market reaction we might have expected.

So this question, oh Dan's disagreeing with me. The initial market reaction was quite powerful because they frontloaded a lot of the announcement. Typically, the ECB goes for the rate announcement and then anything on QUEI or special ops has had to wait for drugs press conference. They went out of the gate at seven forty five New York time,

and out of the gate strong. I think Tracy Markets retraced that in initial move because they heard something else from him, which is that interest rates won't go much lower, and they appeared to listen, all right, we're going to talk so much more about that, but before we do, I want to set the scene a little bit. I want to go back in time to the deep dark days of two thousand eight early two thousand nine. Lehman

Brothers had just collapsed. Money markets were disintegrating. There was a banking crisis, asset prices were falling, and basically it looked like the world was kind of falling apart. But then came the central banks, and suddenly everything was slightly better, and things were pretty good for a while. The economy didn't double dip as some people had warned it would, though there were occasional bouts of volatility, But then the

narrative started to change. Around the turn of this year, more than seven years after the financial crisis, economic growth still hadn't picked up significantly, despite multiple expansion and reprograms, multiple steps of stimulus, trillions of dollars worth of asset purchases. People started talking about this idea, and drug confronted this directly that they run out of ammunition, worrying that they

wouldn't be able to keep markets happy forever. Let's hear what Mario Joggy actually had to say about that ammunition question last week. Well, I think the best answer to this is being given by our decisions today. It's a fairly long list of measures, and each one of them is very significant and devised to have the maximum impact into boosting the economy and the return to price stability.

So we have shown that we are not short of ammunitions on the table for today's discussion is basically markets crisis of faith. Let's call it in central banks and Mohammed, you're actually perfectly placed to discuss this topic because you've just written a book. In your book is called the only game in town, the only game being those central banks. How did you come up with that topic? So it

came from a central banker. I was at a conference in November of organized by the Central Bank of France the Band of France, and the outgoing governor Chris shan Yer opened it and it was attended by lots and lots of central bankers around the world, and I was sitting there and he basically defined the conference in the following term. He said, we have become the only game

in town, and we don't like it. The title comes from him because it really speaks to the fact that central banks have been forced They haven't chosen to, They have been forced to take on more and more responsibility, knowing really well that their instruments are badly suited for the responsibilities that taken on. But they have felt that I had no choice to do it, and increasingly they became the only game in town, and their success has become a function of somebody else. And that's a very

uncomfortable position to be in. And that's why the governor said, we don't like it. We'll talk to us about those instruments and what effect they actually have on markets. So, like you said, the first part of the story is

a simple one, which is post financial crisis. Had they not stepped in, stepped in with whatever it takes, and that means using balance sheets, flooring interest rates, creating markets where markets where dysfunctional, we would have had a multi year depression around the world that would have undermined this generation and probably the next generation. Then comes Phase two. Phase two was in the United States and in Europe.

In at the end of when the immediate crisis is resolved, the patient, if you like, is out of the I c U, but the patient is still not doing really well. Central banks looked around and came to the conclusion that no other policymaker was able and willing to step in, so they, like any doctor would do, Rather than abandoned the patient, they decided that they would continue to treat the patient, even though the medicine they were using wasn't well suited for that, and they sound at times both

resentful and defensive about that. You know, they're absolutely right. They're resentful because they are going from being part of the solution to now causing complications and potentially becoming part

of the problem, and they don't like that. They also know that if our politicians in Europe, in Japan, in the United States where to get the act together, there are measures that have been identified ide that could make things a lot better, and that would allows central banks to normalize and be and remain part of the solution. There's a perception that fiscal policies out to lunch, that

these guys have no choice. In the immediate, very immediate post crisis period, there was a sense that fiscal and monetary were swimming together. Then that narrative broke down. What do you think happened there? The sense of immediate crisis passed. So I remember very clearly when government officials turned up in Washington, d c. In the fall of two thousand and eight and they realized that what they were facing at home was a global crisis, that other countries were

facing exactly the same thing. And at that point there was a common understanding that you need to deploy the whole range of policies, fiscal, monetary and structural, and you need to do it in coordinate fashion. And we had the successful G twenty summit in April two tho and nine in London. Then two things went wrong. One, the mindset remains cyclical. Somehow people believed that since the crisis occurred in advanced countries, advanced countries live in cyclical space,

so this would be a V shaped recovery. You come down very quickly, yes, but you recover very quickly. There wasn't enough appreciation that this was something much more fundamental. It was structural in nature. It was a new normal that there it is new normal, right, and there was no understanding at that point that this was something secular

in nature. The second thing that went wrong is with the sense of immediate crisis behind us, politicians started relaxing and they didn't realize that anger would start growing in society that would make it even more difficult to take bold actions later on. So I think, you know, it was a question of the crisis didn't last long enough,

and the mindset was wrong. And it's ironic that the fiscal policy bankers and we're talking about governments and legislatures that undertook those measures during the crisis, many paid the price, and yet the narrative when they were hounded out of office was you haven't done enough for me. I'm still feeling like it's a recession, even though technically the economies

were expanding. Again, it's pretty ironic, don't you think. I don't know if it's ironic as much as it's a reflection that while the economies were expanding, they weren't expanding fast enough, and the benefits of that expansion we're going to a very small segment of the population, the rich. So what you had is insufficient growth, and the benefits of that growth were not shared in an inclusive fashion,

and that's why people started getting angry. And the reason why that happened is because we relied on finance to get us out of the problem. So private finance got us into the crisis, and public finance a central banks were relied on to get us out of the crisis, and we didn't invest in genuine creators of economic growth. Being you're familiar with the arguments of Ben Banankee and to an extent, Paul Krugman, who say, look as long

as we're here, we're going to keep swinging. We're not going to be the guys who went down in history as allowing another depression to happen. And you have some sympathy for that view, Yeah, I think of central banks as doctors. No doctor will walk away from a patient even if they don't have the right medication. They will remain. So, yes, they will continue swinging, to use your phrase, but they

will become increasingly ineffective. But a fiscal policy is perceived to remain out to lunch, then what choice do these guys have. So are four things that need to happen, fiscal, monetary, structural reforms, and a bit of that forgiveness. If you rule out three of them and just leave monetary policy on the table, which what we have, what we've done, not only do you get inadequate outcomes, but you start getting tensions that ultimately undermine the pathy wrong And that's

where I think we're on now. Because policy monetary policy becomes ineffective. Do you think the political system is up to instituting those three other things you talked about? From an engineering perspective, absolutely, I don't think the engineering of this is difficult. From an implementation perspective, we probably will need some sort of crisis, hopefully a small crisis, to

wake up the political class. I mean, if anything, right now, it seems like we're veering even more towards isolationism, protectionism, and populist outrage at authorities in general. You're absolutely right, and certain things happen when you grow slowly and when inequality goes up. Most importantly, people get angry. Now what do you do when you get angry? You blame your neighbor. And if your neighbor happens to be a foreigner, that's even better. So it's not surprising to me at all

that there's a populous movement. It is not surprising me at all that that we're hearing both sides of the political spectrum the United States talk about protectionism. That is what happens when economies grow slowly for a prolonged period of time. It's rhetorick right now. I don't think that we are going to swing from where we are now to protectionism because it's actually very difficult to get lobbies for protectionism today because we are consumers and producers at

the same time. But what we will get is an emphasis on fair trade, so you'll hear less the phrase free trade, and you'll hear more the phrase fair trade. Let's go back to monetary policy for a second, because we've been talking about fiscal policy. The assumption here being that fiscal policy is possibly the only thing left to help boost economic growth at this point is that you're thinking it's one of the freak of the four components.

So monetary policy can play a role if supported by fiscal policy that matches the will and the wallet to spend. We have separated the will from the wallet to spend, so we have a problem of aggregate demand. We also need to deal with structure reforms to promote genuine engines of growth. That means investing in infrastructure, that means corporate tax reform, that means greater emphasis on labor retooling, and

there's a lot of scope for private public partnership. And then we have to do the very difficult thing and I hate, I would hate doing it because there's huge issues of fairness. But we need to also look at

excessive indebtedness in the system and deal with it. This is particularly acute for Europe in the case of Greece, and it will become acute in the United States with student loans, so debt forgiveness on the table, selective debt forgiveness in the next five years for part of our younger people who have taken on way too much student debt and whose return on education will never be high enough. We've learned a few things from episodes of excessive indebtedness,

particularly what's called the debt overhang. It's one of the contributors to the last decade in Latin American the eighties. When you have too much debt, too things happen. First, it crushes you directly. Second, it discourages any new capital from coming in, so you end up in a vicious cycle that's almost impossible to get out. You see it in Greece every single day. And now there was a there was a risk that we may have this as a headwind to growth. There's not an immediate crisis, but

it will be a headwind to growth. And yet, Muhammad, the central Bank is same resigned to playing this role that has outlived its usefulness. Mario Dragi said at his press conference. Quote the measure driver of the economy and the recovery basically remains our monetary policy. How do they get out of that? So they need we all need the handoff. We need the handoff from prolonged and excessive dependence on central bank policies to a more comprehensive policy response.

Remember when the first central bank went unconventional to pursue economic objectives as as opposed to normalize dysfunctional financial markets, which is August two and ten in the case of the US. Ben Bernacki made it very clear. He said, when you go unconventional, it's about quote benefits, costs and risks. And the longer you see unconventional, the gay to the threat that the benefits come down and the risks and the costs go up. I that the collateral damage and

the unintended consequences exceed the benefits. Central bankers know that, they know that, and yet they're unable to hand off to the more comprehensive So they are in a really difficult situation. And that's why I said at the beginning, they no longer control their destiny, and that makes them

really uncomfortable. Do they worry that the independence of central banks, which has really been a hallmark of the past thirty years, began in the US, But it's spread to the UK, it spread to the Eurosystem members and in the late nineties to Japan. Is that at risk? In other words, their very identity is that at risk from these popularist pressures that you've said a growing Ultimately, will there be a legislative response and is that what they deeply fear

they do? And it is at risk? We already saw the Japanese parliament go crazy over the Bank of Japan when the Bank of Japan took create negative um. In the US, there are calls for greater audit of the central bank. We are very close to a politician realizing that when they expand their balance sheets as the e c P announced would do more of last week, that they really are quasi fiscal agencies. And the minute you talk, you put fiscal in the phrase. Even if it's quasi fiscal,

there's a question, why aren't they coming to parliament for approval? So, yes, central banks are worried, and they're right to be worried. Will they use Will they lose their independence? I don't think it will happen very quickly, but they will find that they will become more political than they have in the past. Do you think one of these days one of these bills in Congress will sneak through. It's really

hard to say then. I mean, so many crazy things are happening on the political side, and some of them are not very rational, so it's hard to say. It really is a risk, and that would be a disaster. It's gone from being very much a fringe view in Congress to almost a mainstream view. The audit the FED, for example, each year gets more and more adherents, but it can't quite get through. That's why I wonder whether one of these days something is going to get through.

It's certainly a risk. I want to go back to the ammunition question for a bit, because it seems like late last year we did suddenly see a chorus of voices expressing concern over the idea that central banks had fired off all the monetary policy shots they had in their collective armory. I guess to stretch the analogy, what do you think about that, Mohammed? Is that true? So they have instruments. I don't think the issues were they

have instruments or not. I think it's how well suited are the instruments for the objectives are trying to pursue and from day one. They weren't perfectly suited, and the longer they've relied on imperfect instruments, the greater the collateral damage. Go back to the example of the doctor. If she or he prescribes you the wrong medication because the right medication isn't available, you will worry about the side effects.

And we're starting to worry about the side effects. It's the old notion that at some point the side effects totally overwhelmed the good that the medication was doing. So yeah, so, so people should be worried. But it's not because of the lack of instruments. It's just that the instruments aren't well suited for the objectives that are being pursued by central banks alone. Mohammed, one last question before we let you go to use your doctor analogy again. How should

we be judging the success of central banks? You know, if they're doctors, they've kept markets alive for this long, but they haven't really treated the underlying illness. So I would give them a plus for effort throughout the whole period. A plus effort. You know, they they have really done enormous I'll give them a plus. Between two thousand and eight and two thousand and ten for the FED for

helping us to avoid a multiyear depression. I would give him a B for buying time for the system between two thousand and ten and two thousand and fifteen, in the hope, the misplaced hope, as it turned out, in the hope that our political class would respond, and I would give them an incomplete as to whether they become part of the problem having been part of the solution. All right, Muhammad al Arian, thank you so much for

your time. Thank you, all right, Dan, Have we come away from that any clearer on whether or not central banks are running out of bullets? I think we've come out of this with an understanding of the framework that that debate is happening in, and few if any, people are as articulate on the subject as our guest. I thought. The idea of fiscal policy is really interesting, especially since we seem to be hearing more and more economists and analysts talk about the need for these sort of measures.

The thing that concerns me, which Mohammed touched on, was this idea that suddenly we're going to have an epiphany and be able to come out of all the politics surrounding those issues and actually tackle things like debt overhangs. How plausible do you think that is? I don't know. There's almost an element of tragedy about this. The Central Banks were widely perceived to have, if not saved the world,

then staved off a second great depression. They're not getting much thanks for their action now, and yet, as Mohammed pointed out, this little sign that fiscal policy makes are willing to help them out of this trap into which they've got themselves. It is tragic. Don't you think it's definitely tragic? It's also definitely interesting times. And I mean that in the classic Chinese curse use of the word right. Okay.

Thanks again to Dan for being my co host for this episode of Odd Lots, and thanks to Mohammed el Arian. His book is the only game in town Central Banks, Instability and avoiding the next collapse. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. You can also follow Mohammed el Ariyan he is at el Arian M. I'm Daniel Moss. You can get me at Daniel Moss d C. Thanks for listening.