All Eyes On Central Banks

Policies by central banks across the world to kick-start the economy haven’t borne fruit as yet, writes Chris Tedder, research analyst at FOREX.com

The eyes of the world remain fixated on the actions and promises of a few key central banks.

These banks hold the hopes of markets and nations on their shoulders. In particular, the market is banking on central banks’ taking decisive action to combat stagnant levels of growth throughout the world, as they only they can. This is something central banks have been attempting to do on-and-off since the start of the US financial crisis that crippled financial markets throughout the world, eventually mutating into the European debt crisis.

The underlying problem is a lack of demand, and without sufficient levels of demand markets/nations cannot grow at a healthy and sustainable pace. To combat this central banks have been easing growth restrictive policies and pumping stimulus into the market. To date, these policies haven’t been able to kick-start the global economy. Hence, more action is required, and has been promised or initiated in some cases, from the global economy’s last line of defence, central banks.

One of the most important modern central banks is the Federal Reserve (Fed), which operates in the US and has two key aims; to maintain price stability and max employment. The most common tool in the Fed’s arsenal is manipulating monetary policy by adjusting short-term interest rates, but it has had to reply on less conventional measures of late. This is because the Fed funds rate is already near-zero. Thus the Fed has started aiming its policy towards reducing long-term interest rates. To do this the Fed enacted operation twist and conducted two round of quantitative easing (QE) and has just announced QE3, with the former based around swapping short-dated securities for longer-dated ones and the latter involving buying government bonds and mortgage backed securities.

Another key central bank is the European Central Bank (ECB), which administers monetary policy for 17 eurozone member states. A key point about the ECB is that it only has one overriding objective, to maintain price stability.
In terms of policy, the ECB has also had to resort to less conventional techniques in an attempt to stave of an economic collapse in Europe. The difference between the ECB and the Fed is that the ECB stills has the ability to lower short-term interest rates if it wanted, but the nature of the European debt crisis means that it has to employ other measures as well.
In other words, cutting interest rates wouldn’t likely save the struggling European nations and banks that are loaded up with massive amounts of debt, albeit there has been some progress on this front. Hence, the measures used by the ECB, long-term refinancing operations and sovereign bond buying to name a couple, are aimed directly at banks and sovereigns.

In China, the world’s largest central bank, the PBoC, faces a different set of problems.

Its problems stem from an overheated economy due to the massive amounts of stimulus pumped into it in response to the financial crisis. Nonetheless, the lack of global growth has played a large part in the slowing of the Chinese economy, along with Beijing’s own attempts to rain in growth by tightening policy. Combined, these problems create a significant challenge for the Chinese government; how to simulate the economy without reigniting the problems that emerged as a result of the stimulus of 08/09.
Beijing’s answer thus far has been a measured attack on weak levels of domestic demand. The PBoC has cut interest rates and the reserve requirement ratio (RRR), which dictates how much capital large Chinese banks must hold in reserve, and there has also been an increase in government spending, although it is far of the steroid injection on 08/09.