Central banks exert powerful influence in both the markets and in the overall economy. An influence that supposedly serves their purpose of reorienting the economy when it departs from the established path, with the ultimate goal of safeguarding the socio-economic interests of all citizens
But their power in this traditional regulatory role may be diminishing. Indeed, the next crisis is approaching as we move forward in the current economic cycle, and this time it seems that the Central Banks are not adequately prepared to combat it.
First of all, it is obvious that, with their regulations, monetary or otherwise, they can help move the market in the direction they so choose. A central bank always has monetary resources of great specific weight within the market as a whole, and its mere movements already have a powerful influence depending on the direction they take.
But in addition, the central banks have something even more powerful: the psychological effect.
And with this psychological fact, without having to spend even one dollar, the cattle of the market will gently drive towards where the shepherd wants. In fact, the clearest demonstration of this point is the cat-and-mouse game that always exists behind the intentionally ambiguous words of the central bankers’ public statements. In this case, the policy is to use uncertainty for socio-economic agents to regulate themselves.
But of course, this does not always work either, and sometimes you have to resort to heavy artillery. A good example of how sometimes statements aren’t enough, is Greenspan’s famous reference to the “irrational exuberance of the markets” that preceded the bubble.com, and that did not prevent the bubble from bursting, affecting millions) of victims.
But, even in the case of central banks, and however much it may seem that their monetary and other resources are virtually infinite, the truth is that they are not. Their artillery is not only limited, hence the importance of enhancing it with the psychological factor, but also must be continually recharged.
One of the main pieces of ammunition that every central bank has is monetary policy, and more specifically interest rates. With these interest rates, the central bankÂ has a great capacity to influence the economy, and based on them, the loans and credits of the market are articulated. But this influence also extends to everything that is indexed to these interest rates, which in practice extends its scope to practically every economic indicator. But monetary weapons do not come free, nor are they available for use at any time.Â
This translates into the practice in which, during times of economic boom, it is necessary to gradually increase interest rates not only to exert a tight control over inflation (and also encourage the creation of employment in the case of the FED) but to then be able to lower them in order to stimulate the economy when necessary.
The true Achilles heel of the current recovery
And it is precisely in this last point where the true Achilles’ Heel of the current recovery lies. This complicated point is in the ultra-expansive policies, both monetary injections and ultra-low (or even negative) interest rates, which have been prolonged over a much longer period than in previous crises. The conclusions can perfectly drawn by yourselves.
In short,Â the next crisis will unload on our economies in all its fullness and with great crudeness.Â The dilemma of central banks is not easy, but this job has never been simple. I do not know if there would be another solution to the equation of the recent Great Recession, but history will be the judge.