Central Bankers Use Moment of Calm to Debate How to Fight the Next Crisis

By Josh Zumbrun Features Dow Jones Newswires

Central bankers, basking in a moment of synchronized growth and a global economy less dependent on easy-money policies, are thinking about what they will do when the next economic meltdown happens.

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European Central Bank President Mario Draghi said Thursday that central banks might need to reuse some of the weapons employed to fight the last war, most notably negative interest rates.

Federal Reserve and ECB officials, who are gathered in Washington for the fall meetings of the International Monetary Fund and World Bank, are using a tranquil period to debate the type of monetary policies central banks might pursue. The world's two most influential central banks signaled no shifts in strategy -- in the Fed's case, to raise rates gradually and shrink its bond portfolio, and in the ECB's, to announce a slowdown of its bond-purchase program as soon as its next policy meeting on Oct. 26.

But while current policies are stepping away from the bond-purchase programs known as quantitative easing, central bankers are opening the door for a future that could include more negative interest rates and periods of higher inflation following recession.

The discussions are still largely hypothetical. Ever since the global financial crisis of 2007-09, central bankers have wished for more moments when they could gather in calm and openly spitball monetary policy ideas without the risk of derailing recovery. That moment has finally arrived.

Mr. Draghi said that negative interest rates, an untested policy for the ECB until 2014, had been a success, and that the decision to push the ECB's target rate into negative territory hadn't hurt bank profitability as critics suggested it would.

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"We haven't seen the distortions that people were foreseeing," Mr. Draghi said at the Peterson Institute for International Economics in Washington. "We haven't seen bank profitability going down; in fact, it is going up."

Mr. Draghi reiterated that the ECB would maintain its negative target rate "well past" the time it steps back from its bond-purchase program, underscoring growing comfort in the negative-rate strategy.

And while Mr. Draghi endorsed negative rates, current and former Fed officials engaged in an unusually open discussion about changing the target for 2% inflation.

That discussion was kicked off by former Federal Reserve Chairman Ben Bernanke, who presented a paper Thursday morning at the Peterson Institute arguing the Fed could overshoot its target for 2% inflation to make up for periods of recession in which inflation ran too low.

While Mr. Bernanke made a similar argument in April, current Fed officials joined in Thursday's debate. The Fed's vice chairman, Stanley Fischer, said in response that the Fed should consider a policy like in Israel, where the central bank targets a range of 1% to 3% inflation. Mr. Fischer ran the Bank of Israel from 2005 to 2013 and said the range gave the central bank more flexibility.

"It would be worth taking a look whether countries that have that range -- we had it in Israel and I found it immensely useful -- have done better or how they've used it," Mr. Fischer said.

Federal Reserve governor Lael Brainard said that Mr. Bernanke's proposal "could guard against premature liftoff and help prevent the erosion of longer-term inflation expectations."

She also focused on the risks of the policy, arguing that a persistently low level of interest rates may pose risks to inflation expectations and financial stability. She focused on the so-called neutral rate of interest, which is the underlying rate of interest that keeps the economy on an even keel and is estimated to be at unusually low levels right now.

A "low-neutral-rate environment may also be associated with a heightened risk of asset-price bubbles," she said.

It speaks in part to the success of central bankers that they are able to have the discussion. For much of the past decade, the Fed and ECB were reluctant to risk rattling a still-fragile global economy by discussing potential strategy shifts. But the discussion speaks also to central banks' failures. Despite steering the economy from a decade of crisis-fighting to a moment of synchronized growth, central banks still haven't revived wage growth or inflation to the extent desired.

IMF Managing Director Christine Lagarde, as well as her counterpart World Bank President Jim Yong Kim, have urged policy makers that this upswing -- which may well be fleeting -- is precisely the moment to have difficult debates and make hard policy decisions.

Fed governor Jerome Powell gave an optimistic speech Thursday on the state of the global economy, saying that signs of a sustainable recovery are materializing that will support central bankers as they step away from the easy-money policies of the past decade.

The U.S.'s return toward a normal interest-rate environment "should continue to be gradual, as long as the U.S. economy evolves roughly as expected," he said.

Write to Josh Zumbrun at Josh.Zumbrun@wsj.com

(END) Dow Jones Newswires

October 12, 2017 18:18 ET (22:18 GMT)