Central banks' repeated warnings that there are limits to what they can do to bolster the sputtering world economy could suggest they are about to pull back and pass the baton to governments. But a steady flow of research and a new tone in the debate among policymakers and advisers points in a different direction: rather than retreat, central banks are preparing for the day they may need to do more, even at the risk of antagonising politicians who argue they already have too much power.
The shift can be seen in the acknowledgement by Federal Reserve policymakers that their massive $4 trillion balance sheet will not shrink anytime soon, or that asset buying may become a "recurrent" tool of future monetary policy. It can be seen in the comments of Bank of England officials who talk of crisis-fighting tools as now semi-permanent fixtures, or in the Bank of Japan developing a new monetary policy framework, in this case targeting long-term market interest rates.
Driving those developments is an emerging consensus among policymakers who now acknowledge that the global financial crisis has led to a fundamental shift toward low inflation, tepid growth, lagging productivity and interest rates stuck near zero. "We could be stuck in a new longer-run equilibrium characterised by sluggish growth and recurrent reliance on unconventional monetary policy," Fed Vice Chair Stanley Fischer said last week.
For years, Federal reserve and other policymakers have discounted such a scenario, arguing that temporary factors were slowing the recovery and plotting a return to conventional pre-crisis policies.
Over the past months, though, that optimism has given way to an admission that such a return is increasingly elusive. Interest rates are set to stay low far longer than thought only a year ago and jumbo balance balance sheets accumulated through crisis-era asset purchases are now cast as a possibly permanent tool.
At the annual Jackson Hole Fed conference in August the discussion had shifted from the mechanics and timing of "normalisation," to how and whether to expand the central bank footprint yet again.
Policymakers still keep reminding governments they should help boost productivity and growth with reforms and, where possible, spending on infrastructure. But there has been a growing recognition among central bankers that they may not be able to simply hand the problem off, and that now is the time to lay the groundwork for more aggressive policies that may be needed down the road.
Existing tools may not be enough "to deal with deep and prolonged economic downturns," Yellen said in Jackson Hole. She has since flagged the possibility that in a future downturn the Fed might need to start buying private securities and not just government bonds, a step already taken in Europe.
During last week's International Monetary Fund meeting, its officials even challenged the decades-old consensus about the seperation between monetary and fiscal policy, suggesting central bankers should support government infrastructure spending with low borrowing rates.
"The current low-interest environment provides an historic opportunity to make these necessary investments," IMF managing director Christine Lagarde said ahead of the meetings. Loose monetary policy could double the growth impact of public spending and allow the debt burden to actually fall, she said. On Saturday, Bank of Japan Governor Haruhiko Kuroda said such "synergy" was already factoring into the BOJ's plans. "By continuing an extremely accommodative monetary policy, fiscal stimulus could be even more effective," Kuroda told a seminar.
The shift has been gradual, but gained momentum this year. Two years ago, Japanese and euro zone policy rates were still above zero, and the Fed published a policy normalisation plan that said the balance sheet would begin to decline once interest rates started to rise. Fed forecasts at the time suggested rates would be on the way up from 2015 onwards.
Yet the Fed has raised rates only once since then and when it did, in December 2015, it gave a taste of things to come. The message was that the Fed would keep its large portfolio until rate tightening was "well under way." Analysts at the Institute of International Finance, the global banking trade group, argued last week that any cuts to the Fed's portfolio are now so far out in the future that it serves as a form of fiscal support by keeping big amounts of government securities off the market and rebating the interest to the Treasury each year.
Over the past year research at the San Francisco Fed and elsewhere has cemented the idea that demographic trends, risk aversion, and the diminished need for physical capital in a service economy, had created a less dynamic world economy where it will be hard to move policy rates much above zero. In this context, central banks' bond holdings, negative rates or even de facto bankrolling of government spending no longer look temporary or all that unconventional..
Still, an even larger footprint for central banks poses a political challenge. There are legal constraints on the European Central Bank and some German and Dutch politicians have argued the ECB has already gone too far with its negative interest rates and bond buying.
In the United States, Republican presidential candidate Donald Trump has accused the Fed of propping up stock markets to help the Democrats, and lawmakers routinely grill Fed officials about plans to shrink the balance sheet.
Saying it will not happen until interest rates rise takes on less meaning as the expected pace of increases slows. Former inflation hawks like St. Louis Fed President James Bullard, for example, no longer worry about the size of the Fed's asset holdings. "Five years ago I would have been saying you are taking a lot of inflation risk," by scaling up asset purchases, Bullard said in a Reuters interview. "There seems to be no urgency now to reduce the size (of the Fed's balance sheet)."
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