LAGUNA BEACH – Earlier this year, financial markets around the world were forced to navigate a perfect storm – a violent disruption fueled by an unusual amalgamation of smaller disturbances. Financial volatility rose, unsettling investors; stocks went on a rollercoaster ride, ending substantially lower; government bond yields plummeted, and lenders found themselves in the unusual position of having to pay for the privilege of holding an even bigger amount of government debt (almost one-third of the total).
The longer these disturbances persisted, the greater the threat to a global economy already challenged by structural weaknesses, income and wealth inequalities, pockets of excessive indebtedness, deficient aggregate demand, and insufficient policy coordination. And while relative calm has returned to financial markets, the three causes of volatility are yet to dissipate in any meaningful sense.
First, mounting signs of economic weakness in China and a series of uncharacteristic policy stumbles there still raise concerns about the overall health of the global economy. Given that China is the second largest economy in the world, it didn’t take long for European officials to reduce their own growth projections, and for the International Monetary Fund to revise downward its expectations for global growth.
Second, there are still legitimate doubts about the effectiveness of central banks, the one group of policymaking institutions that has been actively engaged in supporting sustainable economic growth. In the United States, doubts focus on the willingness of the Federal Reserve to remain “unconventional”; elsewhere, however, doubts about effectiveness concern central banks’ ability to formulate, communicate, and implement policy decisions. For example, rather than viewing monetary authorities’ activism as an encouraging sign of policy effectiveness, markets have been alarmed by the Bank of Japan’s decision to follow the European Central Bank in taking policy rates even deeper into negative territory.