Central Banks Can’t Save the World

A much bigger reality

By Mohamed El-Erian 

The three central bank meetings this week -- the Bank of England, the European Central Bank and the Federal Reserve -- made very good cases for additional stimulus measures, though they failed to specify what these would be.

Equities and certain bonds that had surged on the basis of last week’s verbal assurances by central bankers and political leaders sold off. There was no panic given central bankers’ promises to do more in the future should additional action be needed. This is what the standard narrative has been.

But it misses important context, and there is more at play here. The unfortunate reality is that, unlike during the financial crisis of 2008 and 2009, central banks can’t be the saviors this time around for a struggling global economy. Other government entities, with better-suited policy tools, need to step up to the plate.

Why did central bankers disappoint so many this week? I suspect that they wish to keep pressure on other policy makers who demonstrate none of the necessary urgency. The bankers also realize that their policy tools are increasingly less effective. To quote Mario Draghi, president of the ECB, central banks “cannot replace governments.” There’s something else: Central bankers more than anyone are being careful to keep dry whatever ammunition they still have.

Banking Flexibility

This week’s events also highlight how central banks’ operational flexibility is much less than what is commonly assumed. Here, the ECB is particularly important given the enormous risk that Europe’s crisis poses for the global economy, including the U.S.

Last week in London, Draghi left no doubt as to his commitment to do “whatever it takes” to safeguard the euro. He also introduced a shrewd sequence to bring sovereign spreads and yields within the mandate of the ECB and try to contain borrowing costs for struggling peripheral economies. He did this by suggesting that the “exceptionally high risk premia” are undermining countries like Italy and Spain, and that concerns about the robustness of the euro as a currency are contributing to the fragmentation of the financial system and clogging the monetary policy transmission mechanism -- and that, clearly, this needed to be addressed.

Yet Draghi felt compelled Thursday to make additional ECB measures conditional on countries being allowed to access Europe-wide rescue facilities that aren’t under the purview of the central bank. He questioned how his London speech was interpreted, suggesting that markets misread what he meant. He also had to deal with talk of divisions inside the ECB’s governing council.

All this speaks to the much bigger reality, which is of great relevance for individuals, companies, investors and governments around the world. Yes, central banks may be part of the solution, but increasingly they will play a smaller and smaller role. The tools they have available are losing their firepower. The burden is now on other policy makers and the political leadership. Only they have the tools that can address the fundamental problem of too little growth, too much debt in the wrong places, and too little private capital being channeled to investment and other productive activities.

To solve Europe’s crisis and the world’s intensifying economic malaise -- just witness the downturn in manufacturing - - policy makers and their political bosses need to address issues of competitiveness, fiscal reform, and the retooling and retraining of the labor force. The longer the delay, the more likely these problems will get embedded in the structure of the economies.

Of course, none of this will happen until political leaders abandon their tactical, incremental and partial approaches for issues that require strategic, coordinated and comprehensive responses. Unfortunately, in today’s polarized world, the prospects of this are far from reassuring.