Whether to taper is the question facing central bankers as they debate when to unwind the massive economic support measures deployed last year to prevent another Great Depression on the back of COVID-19.
“The withdrawal of monetary and fiscal support is inevitable. The key question is timing,” M&G Investments fund manager Eva Sun-Wai said.
As the US Federal Reserve and other central banks hold meetings this week, here are key questions regarding their monetary policies:
Last year, the Fed, the European Central Bank (ECB), and their peers in Japan, the UK and elsewhere brought down interest rates and unleashed huge asset-buying programs to prevent an economic catastrophe.
The goal of the programs is to keep economies humming by making it cheaper for people, businesses and governments to borrow money.
The Fed, which begins a two-day policy meeting tomorrow, slashed rates to zero percent at the start of the COVID-19 pandemic in March last year.
To provide liquidity to the world’s biggest economy, it is buying at least US$80 billion per month in Treasury debt and at least US$40 billion in agency mortgage-backed securities.
The ECB has a pandemic emergency purchase program of 1.85 trillion euros, allowing the bank to buy assets in financial markets, such as bonds, making their prices rise and interest fall.
The ECB has kept the rate on its main refinancing operations at zero percent.
Inflation has soared worldwide, raising market expectations that central banks are likely to tighten the money supply to lower prices and prevent economies from overheating.
Central banks in Brazil, Russia, Mexico, South Korea, the Czech Republic and Iceland have raised their interest rates this year.
However, the Fed, the ECB and the Bank of England (BOE) — which also meets this week — have so far hesitated to lower their interest rates.
Officials at the Fed, ECB and BOE have said that inflation is only temporary and a consequence of prices recovering from drops at the height of the pandemic last year.
Policymakers want to avoid harming the economic recovery by withdrawing too much support too quickly.
Markets have been reacting to every economic indicator — from inflation to unemployment and consumer spending — in a guessing game over whether they are likely to make central banks adjust their policies earlier or later than expected.
Bank officials have been carefully weighing their words.
Fed Chairman Jerome Powell last month said that the bank might “start reducing the pace of asset purchases this year,” but he remained tight-lipped about the timing.
The ECB went a step farther this month, deciding to slow the pace of its monthly bond purchases, but it did not change the size of the scheme, nor its end date of March next year.
“This is a long way from being a ‘full taper,’” London-based Capital Economics chief global economist Andrew Kenningham said.
ECB President Christine Lagarde has clearly laid out her plan, saying: “The lady isn’t tapering.”
Markets expect a clearer signal from the ECB in December.
The global economy is recovering as people, businesses and governments have taken advantage of ultra-low interest rates.
Meanwhile, governments have pumped US$16 trillion into fiscal stimulus programs worldwide, IMF data showed.
“We learned a lot from previous crises and the management of the COVID-19 crisis has been almost perfect from an economic point of view,” JP Morgan Asset Management global market strategist Vincent Juvyns said.
“The recovery is sharp and massive, and we didn’t experience mass unemployment or a wave of bankruptcies,” he added.
S&P Global Ratings said that the default rate in Europe should fall in the near term, “particularly if the policy retraction proceeds in an orderly fashion, as expected.”
Critics have said that the ultra-loose monetary policies only worsen inequality by inflating prices of financial assets and raising real-estate prices.
The ECB defends its actions by pointing to studies by affiliated researchers, which say that its policies have helped curb unemployment, giving a boost to more modest households, which have also gained access to property thanks to lower rates.
An Organisation for Economic Co-operation and Development report early this month voiced concerns about potential negative side effects that prolonging easy money policies could have on prices of financial and real-estate assets.
“The interventions by central banks only make sense if they avoid a recession,” said Nicolas Veron, economist at the Peterson Institute and the Bruegel think tank.
“If they are no longer needed to avoid a recession, they have much more adverse than positive effects,” he said.
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