The third week of January was out of control from a global economic perspective. It was kind of like the economic equivalent of a Girls Gone Wild video: “Central Banks Gone Wild!”
In just one week, the central banks of four major nations all announced significant moves. The biggest was the announcement by the European Central Bank (ECB) that it would embark on a bond-buying program similar to the U.S. Federal Reserve’s recently concluded Quantitative Easing (QE) program. The ECB will buy 60 billion euros worth of bonds a month until at least September of 2016, or a total of about 1.1 trillion euros in bond purchases.
Through this program, the ECB hopes to avoid a damaging deflationary spiral by raising the inflation rate in the Eurozone up to a target of two percent and, in the process, revive the stagnant European economy. The program is being viewed favorably by both European and U.S. stock markets: The former soared to seven-year highs on the day of the announcement, while both the Dow Jones Industrial Average and the S&P 500 rose 1.5 percent.
Going Beyond the ECB’s QE
The ECB’s QE program got the bulk of the headlines and publicity, but three other central banks last month also made significant economic moves. These included:
- The Bank of Canada — On January 21, Canada’s central bank announced a surprise quarter-point interest rate cut to try to spur economic growth that is being threatened by falling oil prices. Canada’s overnight rate target now stands at .75 percent.
In the press release announcing the rate cut, the Bank of Canada stated: “This decision is in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada.”
The Bank of Canada acknowledged that inflation has remained close to its target of two percent in recent quarters. Core inflation has been boosted by “sector-specific factors and the pass-through effects of the lower Canadian dollar,” according to the press release. However, total CPI inflation is now starting to reflect the fall in oil prices.
The oil price shock increases downside risks to inflation and also the risk of greater financial instability in Canada’s economy, the Bank of Canada believes. Its interest rate cut is “intended to provide insurance against these risks … and bring the Canadian economy back to full capacity,” the bank affirmed.
- The People’s Bank of China (PBoC) — On January 22, China’s central bank announced that it would inject 50 billion yuan (or $8 billion) into its banking system to try to stem outflows of cash from the Chinese economy. It accomplished this using seven-day reverse repos, which are a short-term lending facility to commercial banks. January of 2014 is the last time China’s central bank used this short-term monetary tool.
Most observers believe that the PBoC wanted to inject cash into the Chinese banking system before the Lunar New Year holiday started this month, since the Chinese typically spend extra money during the celebration. The move also may have been intended to calm the markets after the week of January 19, when Chinese stocks suffered their biggest losses in six years.
It turns out that this cash injection was just the beginning for the Chinese central bank, however. On February 4, the PBoC made an unexpected cut to the required reserve ratio (RRR) of China’s major banks. It reduced the amount of cash that banks must hold as reserves by 50 basis points, to 19.5 percent, the PBoC’s first such move in nearly three years. The move should free up 600-650 billion yuan (or $96-$104 billion) in liquidity, which would encourage more bank lending while helping to offset the effects of recent cash outflows from the Chinese economy.
Most economists viewed this as the latest shift by the PBoC toward more aggressive monetary easing, and many expect more of the same in the near future. Last year, the Chinese economy grew at its slowest pace in 24 years, and recent economic data indicates that growth momentum will continue to slow this year.
- The Bank of Japan (BOJ) — On January 20, Japan’s central bank announced that it would continue its unprecedented economic stimulus efforts by increasing its monetary base by 80 trillion yen (or $674 billion) per year. It will do so by buying Japanese government bonds, ETFs and real estate investment trusts (REITs). The BOJ also cut its inflation forecast to just one percent (from 1.7 percent), far below its two percent target, citing low oil prices as a major factor in its decisions.
In making the announcement, the BOJ acknowledged that lower oil prices should benefit the Japanese economy over the long-term, since lower energy costs will put more money in the pockets of Japanese consumers. It raised its growth estimate for the next fiscal year (which starts in April) to 2.1 percent. Most economists expect the BOJ to expand its stimulus even further later this year in order to boost inflation up to its target range.
Last month’s announcement is the next phase of what the Wall Street Journal in October 2014 called “extreme stimulus” measures, when the BOJ first said it planned to inject trillions more yen into the nation’s struggling economy — especially its long battle against deflation.
End of an Era?
Such economic stimuli and financial manipulations by the central banks of major nations represent both good news and bad news. The good news is that central banks are taking proactive steps designed to stimulate economic growth and maintain a healthy rate of inflation. The bad news is that these moves are still necessary in many other nations, even though we are more than five years removed from the end of the financial crisis and Great Recession.
Recently, former Treasury Secretary Larry Summers summed up this sentiment well: “I think we need to realize the era of central bank improvisation as the world’s principal growth strategy is coming to an end.”
Indeed. Eventually, the world economy needs to reach the point where it can survive and thrive on its own — without help from the central banks.