Fed, ECB Running out of Ammo in Fight Against Economic Downturns
The Federal Reserve and the European Central Bank are struggling mightily to invigorate their economies at a time when growth is slowing, governments remain on the sidelines and the banks’ usual stimulative tools appear less effective than in the past.
“The Fed is essentially pushing on a string, and they have been for a while. The ECB has been as well.”
On Thursday, the ECB delivered a blast of monetary stimulus to try to rescue Europe’s teetering economy in the face of sputtering growth and uncertainties caused by the U.S.-China trade conflict and Britain’s expected exit from the European Union.
The Fed is set to follow with its own stimulative move next week — its second modest interest-rate cut of the year. The U.S. economy looks far sturdier than Europe’s, and the Fed’s action is seen as a pre-emptive bid to help sustain a decade-long expansion.
Other central banks are lowering rates to try to counter damage from weakening economies and global trade conflicts. Their efforts will throw a spotlight on a growing debate: Just how effective can these actions be when interest rates are already ultra-low — in Europe’s case negative — and many businesses and households are reluctant to borrow for reasons unrelated to interest rates?
“The Fed is essentially pushing on a string, and they have been for a while,” said Russell Price, chief economist at Ameriprise Financial. “The ECB has been as well.”
Interest rate cuts are intended to encourage more borrowing and spending by people and companies. That spending, in turn, tends to accelerate growth and energize economies. Lower mortgage rates, for example, typically lift home sales. And cheaper borrowing can lead businesses to take out loans and expand and hire.
But home sales are sluggish in the U.S. and Europe. And the main problem, Price notes, is a lack of available homes for sale, not high mortgage rates. In the U.S., long-term mortgage rates are below 4%. Businesses are loath to invest mainly because of deep uncertainties surrounding President Donald Trump’s trade policies.
Yet that’s not stopping the central banks from trying.
On Thursday, the ECB approved several measures: It cut the rate on deposits it takes from banks to minus 0.5% from minus 0.4%, a penalty that pushes banks to lend their excess cash.
The ECB, which sets policy for the 19 countries that use the euro currency, also said it would restart its bond-buying stimulus program. This program pumps newly created money into the financial system to lower borrowing costs and help the economy. The ECB will buy 20 billion euros ($22 billion) a month in government and corporate bonds for as long as needed.
Furthermore, the central bank extended its pledge to keep rates at record lows until inflation returns to its target of just under 2%. At last count, it was just 1%.
And the ECB moved to offset the impact of negative rates on banks by exempting them from paying interest on some of their reserves. That was intended to address concerns that negative rates would drain profitability from the banking system over the long run.
European companies are more reliant on their banks for capital, compared with U.S. companies, which are more likely to sell bonds or issue stock.
Economic growth in the eurozone slowed to 0.2% in the second quarter from the quarter before. Germany, the largest member of the euro, shrank by 0.1%, putting it on the verge of a recession.
Some analysts think the Fed will have more success supporting the U.S. economy because it is trying only to prolong an expansion, whereas Europe is closer to an outright recession. The Fed, with its benchmark rate at 2% to 2.25%, also has more room to cut rates than the ECB does.
“The starting point for the economy matters,” said Eric Winograd, U.S. economist for AllianceBernstein. “Our recovery is better entrenched and more stable than theirs is.”
Price and Winograd see little downside to the central banks’ moves, particularly in the case of the Fed. U.S. banks are enjoying solid profits, and the ECB has taken steps to support its banks. Both say that the stock market isn’t in a bubble and that other assets aren’t overpriced.
Megan Greene, an economist and senior fellow at Harvard Kennedy School, is less optimistic about the Fed’s ability to speed growth, given that borrowing costs are already so low.
According to the National Federation of Independent Business, small companies are easily able to get the loans they need. Just 4% of small businesses said they haven’t been able to borrow as much as they want.
“If even the little guys can get capital, it’s not a problem,” Greene said.
In a nod to the reality that central banks alone can’t save their economies, the ECB’s Draghi said it was “high time” for governments to get more involved in supporting the economy. Draghi said that active fiscal policy — government spending on growth-friendly projects , for instance — could help end the current unusual period of negative rates.
So far, such calls have been ignored in the eurozone’s biggest country, Germany. It has insisted on balanced budgets despite pleas from the IMF and others to spend more on infrastructure, like extending high-speed internet to all areas of the country.
More government stimulus in the form of greater spending or tax cuts is also unlikely in the United States, Greene said, with elections looming and the budget deficit forecast to hit $1 trillion this year.
Lower interest rates also tend to weaken a currency. This can help a country’s exporters — a fact Trump tweeted about Thursday as he pushed the Fed to cut rates below zero, like the ECB.
European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports…. And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!
— Donald J. Trump (@realDonaldTrump) September 12, 2019
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