The US and the eurozone face daunting economic challenges in a world of low inflation and interest rates, and central banks alone do not have the tools to cope.
That was the message delivered to the American Economic Association’s annual meeting on Sunday by former European Central Bank (ECB) president Mario Draghi and former US Federal Reserve chair Janet Yellen.
“I believe that for the euro area there is some risk of Japanification, but it is by no means a foregone conclusion” if it acts comprehensively to avoid a deflationary malaise, Draghi said via a video link to the conference in San Diego, California.
“The euro area still has space to do this, but time is not infinite,” he added.
Yellen, now at the Brookings Institution in Washington, said she agreed with former US secretary of the treasury Lawrence Summers that the US was enmeshed in secular stagnation — a state where desired savings are bigger than investment and interest rates are depressed as a result.
She ticked off a number of structural forces holding down interest rates — including an aging population and sluggish productivity — and suggested that they might be around for a while.
“These factors are apt to prove chronic by nature,” she said.
Draghi took eurozone governments to task for working at cross purposes with the ECB’s efforts to aid the economy in recent years by pursuing restrictive fiscal policies.
“This is why the ECB has been consistently calling for fiscal policy to play a stronger role and capitalize” on the low rates, he said.
He counseled policymakers in Europe against becoming resigned to slipping into deflation.
“It is certainly not too late for the euro area to avoid this,” he said, adding, “The euro area is not in a deflationary trap.”
Yellen said that monetary policy in the US should not be written off as a policy tool to combat recessions just because interest rates are so low.
She agreed with her predecessor, former Fed chair Ben Bernanke, that quantitative easing and forward interest-rate guidance can be effective in providing stimulus to the economy.
However, while “monetary policy has a meaningful role to play, it’s unlikely to be sufficient in the years ahead,” Yellen said. It “should not be the only game in town.”
“We can afford to increase federal spending and cut taxes” to support the economy in a recession even though government debt has risen sharply in recent years, the former policymaker said.
Yellen did, though, express concern about financial stability risks arising out of an extended period of low interest rates.
She also bemoaned the paucity of macro-prudential tools the US has to deal with that.
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