Bloomberg's Linda Yueh: Some central banks running out of options, wading into fiscal arena

Central bank policy in the US and Europe has expanded in both scale and scope over the last several years, as is typical during recessions. Yet, 3 years after the 2008 financial crisis and subsequent economic downturn, the economies of the US, UK and EU are still struggling. Critics are beginning to speculate that central banks are running out of policy options. We spoke with Dr. Linda Yueh, Bloomberg TV's economics correspondent and a fellow at Oxford, on expanding central bank policy mandates and their options for future policy.

“I think [central banks'] influence has certainly grown since the financial crisis, probably because they seem to be remarkably good at targeting inflation and preserving strong growth. But what has certainly changed over the past couple of years is the recognition that a lot of the financial regulatory powers that were taken away from central banks meant that there was too big a disconnect in what actually happens in the financial markets when central banks set interest rates. For that reason, we are beginning to see the consolidation of power into central banks. You certainly see it in the Bank Of England – Britain is actually abolishing the Financial Services Authority and making it part of the Bank of England – and you see it in other central banks as well.”

“Some argue that these banks are even wading into the fiscal arena. That's certainly a criticism that has been levied at the European Central Bank, for restarting their government bond buying program. If you look at this from the perspective of what a central bank should do, it really shouldn't be going around buying selective government bonds just to bring down the borrowing costs.”

It would certainly seem that the ECB is stretching its mandate. As Yueh points out, however, it may be that central banks are simply responding to a lack of leadership in the stagnant US and Eurozone governments:

“I think central banks have become extraordinarily powerful, in large part because treasuries and governments have a real fiscal constraint these days and that limits what they can do. If you want to stimulate your economy, tax cuts and increases in government spending aren't going to fly these days in the West. So that really means the central banks are in charge of moderating and stimulating.”

Indeed, central banks have been the only entities capable of acting decisively with monetary and fiscal policy in the last several years. But even they appear to be running out of options as of late. Some argue that the Federal Reserve in particular has painted itself into a corner. The Fed has already committed to a further two years of zero interest rate policy and its previous rounds of quantitative easing have been largely ineffective.

“I think because interest rates are already at 0%, everybody is scrambling around to see what else can be used. The problem now is that even if you were to release credit and increase the money supply, if you have deleveraging going on amongst your own consumers, there still isn't a growth engine that firms will response to. In other words, unless exports are really strong or firms are able to sell overseas, firms don't demand funds to invest and grow unless the see a solid source of demand. It's not clear to me that quantitative easing can provide that source of demand. It certainly boosts things like asset prices, but whether or not that actually can speed up the deleveraging process of households, which is one of the biggest drags on US growth, isn't so clear.

After this summer's hysterical debt ceiling “debate,” it would seem unwise to expect decisive action from Congress on this matter. For now, then, we can only wonder what new tricks the Fed has up its sleeve.