The Federal Reserve and other central banks will eventually find separation not easy after partnering with their governments and financial markets to prevent a pandemic-induced depression.
“They are increasingly sticking to what I call a dead end paradigm,” Allianz SE chief economic adviser and Bloomberg Opinion columnist Mohamed El-Erian told a discussion last week.
Central banks are stopping to do everything possible, boosting financial markets with huge asset purchases and pushing government borrowing costs to record lows.
Fed Chairman Jerome Powell has repeatedly called for more aid to support the economy. “The recovery will be stronger and faster if monetary policy and fiscal policy continue to work side by side,” he said.
The problem may begin once the virus vaccine is approved and distributed and the economies of the United States and the world begin to normalize. If the Federal Reserve and other central banks are limited to reducing the emergency stimulus at this time, the continuing flow of liquidity could stimulate asset bubbles and even too rapid inflation.
Rebecca Patterson, director of investment research at Bridgewater Associates, said she saw some arguments that the United States would eventually see faster inflation due to the ongoing aggressive fiscal stimulus. „. Whether we understand it or not, preparing for this risk scenario is quite important. “
Patterson said economic policy has entered a new paradigm, with independent central banks and governments working closely together to fight the pandemic. Monetary policy makers buy government bonds, while fiscal policymakers issue more,
Former Fed Governor Randall Kroszner agreed. The large debts that governments accumulate “will make it harder for central banks to raise interest rates when they feel the need to do so” because it will increase borrowing costs, he said.
The Federal Reserve will also find it difficult to cut its huge balance politically after Congress effectively authorizes an increase by allocating money to the Treasury to set up emergency lending facilities at the US Federal Reserve, said Kroszner, now a professor at the University of Chicago.
The flood of debts can have other consequences. The Treasury market is already so large that it may not be able to function smoothly on its own during stress, according to Fed Supervisor Randall Quarles.
Former Fed Chairman Janet Yellen said she expects the Fed to provide more guidance on its plans for future asset purchases. But the purpose of the purchase would be to cut interest rates, not to fund the federal government.
Source: Bloomberg Pro Terminal
Chart: Used with permission from Bloomberg Finance L.P.
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