The third quarter of 2012 was quite extraordinary, not just for the sheer number of central banks announcing changes to monetary policy but for the way in which policy boundaries evolved.
The European Central Bank’s new programme of unlimited outright monetary transactions evidenced a more creative way of thinking that we felt was missing from previous propositions for the euro area.
It showed a shrewd analysis of the realities at work in the sovereign bond markets – wider spreads between core and peripheral government bond markets being driven by an ‘irrational’ fear of a euro break-up – and has delivered a potentially credible solution, such that sovereigns are fully backstopped in meeting their ongoing funding requirements.
The terms of the OMTs are also couched in a way that encourages rather than hampers the reform process; countries will first have to apply to the European Stability Mechanism for a bailout subject to certain conditions. And all of this has been engineered without the ECB stepping beyond its statutory remit.
Although the proof will undoubtedly be in the pudding – investors will need to see OMTs working successfully in practice, the initial signs are encouraging.
While Spain has so far hesitated to apply for a ‘precautionary’ bailout, we view the country’s own initiatives, such as intensifying labour market reforms, as an indication that it may be trying to strengthen its position ahead of potential negotiations with its European partners.
Across the Atlantic, US monetary policy also moved deeper into uncharted territory, with the Federal Reserve’s decision to purchase US$40bn of mortgage-backed securities each month. In a move unprecedented in the history of the central bank’s policy, no pre-determined limits were set on the duration or size of the programme. Instead, the Fed stated that the US employment picture must improve substantially before it ceases its operations.
During all of these developments, we have observed that markets have been extraordinarily sanguine about money printing.
One wonders, perhaps, whether they would have been quite so cheerful if, say, a politician rather than a central bank had targeted a specific number of jobs to be created, or a rate of unemployment under which QE3 would cease.
One real danger is that we have no historical precedent for assessing the longer-term effects of authorities printing money whilst being at their fiscal limits, and on such a global scale. The US Fed’s open-ended commitment to purchasing assets to support jobs suggests that this may be at the expense of tolerating higher inflation levels in the future, despite its dual mandate.
On the other hand, it is difficult to tell what our world would have looked like without unconventional monetary policy.
Business confidence up until now has remained a tricky area. Perhaps open-ended programmes will start to have the desired effect of ending the ‘deadlock’ situation between government and business.
Alan Greenspan, a former Chairman of the US Fed, summed it up when he said that corporate decision-makers and entrepreneurs have essentially been “on a capital strike”: few have wished to build long-term assets, like factories and buildings, or engage in acquisitions, or hire more aggressively in an environment where the medium-term outlook is perceived to be unusually uncertain.
Ironically, if corporates were to start to mobilise even a small fraction of this cash, it would create a positive reinforcing spiral, boosting personal disposable income, and with it consumption. Consumer spending itself accounts for approximately 70 per cent of the US economy.
Other than the shift towards more open-ended monetary policy, which may be beneficial, other areas that could reverse the capital strike are changes to regulation and taxation.
In this respect, we are looking for evidence that politicians and policymakers are not just applying their ‘creativity’ to stealing the next morning’s headlines at the expense of longer-term thinking.
Bill McQuaker is head of multi-asset at Henderson Global Investors