Central Bank Landscape

SMITH BRAIN TRUST – Central banks around the world are once again lowering interest rates and looking to unconventional monetary policy tools, aimed at bolstering their economies.

The U.S. Federal Reserve has cut interest rates three times this year. European Central Bank cut its overnight deposit rate in September. The Reserve Bank of Australia lowered its key rate. And central banks in India, South Korea, Hong Kong, Brazil, Saudi Arabia and China also have adopted easier monetary policy.

Elinda F. Kiss, associate clinical professor of finance at the University of Maryland’s Robert H. Smith School of Business, is a central bank watcher. In a recent interview, she offers context to the central bank moves around the world. A three-time recipient of the Allen J. Krowe Award for teaching excellence, Kiss teaches corporate finance and banking to both undergraduates and MBAs at Maryland Smith.

Q: What is your read of the current state of monetary policy around the world? And why are so many central banks moving to lower their key interest rates?

Kiss: The tariffs/trade wars have cost the U.S. economy $7.8 billion in lost GDP in 2018, according to a study by U.S. economists. Annual consumer and producer losses from higher costs of imports totaled $68.8 billion. ‘After accounting for higher tariff revenue and gains to domestic producers from higher prices, the aggregate welfare loss was $7.8 billion,' or 0.04% of GDP, the researchers said. According to Kristalina Georgieva, the IMF’s new managing director (a Bulgarian economist and former chief executive officer of the World Bank), the U.S.-China trade war could mean the loss of around $700 billion for the global economy by 2020. ‘Everyone loses in a trade war,’ said Georgieva, who took over the helm of the international finance agency last month.

Q: Do you expect that the current monetary easing measures will meet policymakers’ expectations?

Kiss: While this is difficult to project, the Fed has had to lower its target interest rate to levels that it should not have needed if it were not for the trade war. The Fed had been raising interest rates until the trade war hurt the economy. Moreover, Fed Chair Jerome Powell recently told Congress, ‘The current low-interest-rate environment may limit the ability of monetary policy to support the economy.’ He made the statement in testimony before a hearing of the Joint Economic Committee on Nov. 13, 2019.

Q: In the global financial crisis of 2008-09, economies depended upon unconventional monetary policy to create stimulus and avert a deeper catastrophe. How do those measures, and that time, differ from what’s now being seen in economies around the world?

Kiss: Central banks in 2008-2009 were reluctant to lower interest rates below zero; hence they had to use asset purchases and other unconventional monetary policy. While we are not now in a ‘Great Recession’ and won't know for at least two quarters whether that will change, most economists would classify the current situation as a slowdown, but not a recession, and certainly not a depression. The U.S. economy, for example, has a low unemployment rate but employers cannot fill some jobs. To grow the economy, we must either grow the labor force or grow productivity. The corporate tax cuts passed in 2017 were supposed to lead to more investment in technology that would have increased productivity, but that has not happened. Restrictive U.S. immigration policies have limited U.S. workforce growth, but when global growth is the focus, immigration policy is irrelevant.

Q: As central banks adopt easier monetary policy, some economies, even in the developed world, are seeing negative interest rates. What are the implications for negative interest rates, and the long-term consequences?

Kiss: Economist Miles Spencer Kimball has argued that if the Federal Reserve had reduced the Federal Funds rate (the short-term interbank funding rate, which is the key target of Fed monetary policy) below zero, the Fed would not have needed to keep rates at the lower bound for so long. He and other economists believe that the impact on the economy from cutting rates from negative 0.25% to negative 0.5% should not be any larger than the impact of cutting from 0.5% to 0.25%. But I do not agree. My major concern with negative interest rates is that banks are not eager to charge their depositors to lend them money, and if the banks are earning negative returns by buying government debt, their profits can suffer.

Q: What is your view of the current environment of monetary policy easing as it relates to inflationary pressures across developed economies?

Kiss: In the United States, inflation remains soft, below the Federal Reserve’s target rate of 2.0%. Inflation has not been a problem here. Wages have not risen much despite the low unemployment rate. Inflationary pressures have come from higher prices that consumers have had to pay because of the increased tariffs.