Restoring Central Banks’ Credibility
The old central-bank playbook of slashing interest rates to spur consumption, investment, and employment has become less effective since the 2008 financial crisis. Yet without effective tools and the public's confidence, central banks will be unable to rise to the occasion when the next recession arrives.
ZURICH – Recent jumps in equity prices and bond yields suggest that recession fears are receding. But the global economic expansion cannot last forever, and when the next recession comes, central banks may not be adequately prepared to respond. Enhancing central-bank credibility to bolster the effectiveness of monetary policy is thus an urgent priority.
Before the 2008 financial crisis, central bankers could rely on slashing interest rates to spur consumption, investment, and employment. But that playbook no longer works as well as it once did. One reason is elevated uncertainty, owing to globalization, societal aging, changing consumer preferences, growing income and wealth inequality, rising health-care costs, rapid technological change, and other factors. Even in the absence of recession, for many households and businesses, the future seems daunting and unpredictable.
This uncertainty will exacerbate the downturn when it comes. When uncertainty spikes, low or even negative real (inflation-adjusted) interest rates may not induce higher spending. Rather, savings may rise and investment may falter even as interest rates plunge. If governments are unwilling or unable to boost demand with fiscal policy, the result will be a prolonged and deep economic slump.
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