US Fed stasis underlines predicament faced by central banks

Can we be confident that central banks will succeed in returning world economies to some kind of normality? Ironically, the answer is in the question: if investors, businesses and consumers believe the medicine is working, then it probably will.

The evidence suggests, however, that central bankers face a bit of a crisis of confidence – eight years after the economic crisis hit, economic growth remains low and inflation is almost completely absent in the developed economies, except in the United States, where both annual growth and inflation are just over the hardly stratospheric level of 1 per cent.

The problem for central bankers is that they have already used up a large part of their ammunition. When interest rates are at zero, you can theoretically cut them into negative territory, but it may not make a lot of difference. When you are already pumping in billions into an economy via bond purchases, you can always put in more, but it may feel, as the old saying goes, like you are pushing on a piece of string.

Bank of Japan

The Bank of Japan is more advanced and experienced in the string-pushing department than most, and still hasn’t cracked it. On Wednesday it announced a policy shift, saying it aimed to overshoot its 2 per cent inflation target – as opposed to just meet it – and also that it would try to hold 10-year bond interest rates at zero per cent for the foreseeable future. After years of trying, such technical changes may not make much of a difference.

Later in the day, the US Federal Reserve board grappled with its particular problem – whether it should edge rates up to a hardly stratospheric 0.5 per cent. In the event it didn’t, though analysts now expect it will move in December. Still, this would mean just one rate change this year, as opposed to the four that had been signalled.

It all shows how difficult it is to escape from an era of low growth and low interest rates. Central Banks have done a lot of the heavy lifting in recent years in trying to stimulate economies. The problem is, if they are running out of ammunition, national exchequers do not have a lot of spare cash to step in with their own expansionary measures.