The fear of “no game in town”

Will 2019 see the start of a recession? Consensus says no, but the financial market slump in December shows that investors are now demanding higher risk premia. To our minds, this is not so much a reflection of changing real economic fundamentals but rather a deeper-rooted concern that we are shifting from the situation where central banks were “the only game in town” to one with “no game in town”.

Already in 2018, several policies, well outside the control of central banks, sparked a mounting sense of unease. In the United States, there is a very visible clash between a large scale fiscal policy stimulus late in the cycle and the need to normalise monetary policy to stem potentially destabilising inflation risks.

President Trump’s recent tweets criticising Federal Reserve Chair Powell only reinforce such fears. Further concerns stem from the on-going trade tensions between the United States and several of its main trading partners, and a general sense of less appetite for global policy coordination.

In Europe, the muddled state of Brexit, risk relating to the fiscal situation in Italy and the recent wave of social unrest in France have sparked additional worries and shone a spotlight on the still incomplete architecture of the euro area. While there is broad political agreement that Banking Union must be finalised, and decisive action taken on Capital Markets Union and Fiscal Union, there is still significant disagreement as to how and when these goals should be achieved.

Finally, in China, policymakers continue to struggle with the conflicting goals of taming the country’s corporate debt mountain without triggering financial instability and an economic slump. More broadly speaking, the current global policy tensions combined with a strong dollar, have cast a dark cloud over emerging economies.

As such, while the underlying real economic fundamentals suggest that there is room for further life in the current expansion, there is seemingly little policy ammunition to fight downside risks. Economists, investors and central bankers alike have long been concerned that monetary policy has been overburdened in the post-crisis world. The initial idea was that central banks, in easing financial conditions, would provide demand side support and thus buy time for the necessary adjustment of excessively leveraged balance sheets and the implementation of growth-boosting structural reform.

Trouble is that governments have failed to sufficiently deliver on their side of this implicit bargain and central banks are today low on ammunition to fight a new downturn, and this for several reasons. First, while bank balance sheets have undeniably been strengthened post-crisis, leverage on government, household and corporate balance sheets remains elevated leaving less room for the global economy to take on new leverage and thus boost demand through the credit channel. Moreover, the fact that interest rates are already at very low levels raises the question as to what more central banks could do to alleviate the already highly indebted balance sheets. Cutting rates even lower, could, paradoxically, have the unintended consequence of tightening credit conditions as banks would find it difficult to pass on negative rates to retail depositors and may thus be forced to simply scale back lending. Finally, new large-scale asset purchases by central banks could see them come under renewed fire for increasing wealth inequality and may, moreover, be limited by political constraints in the euro area.

Several populist politicians have suggested that central banks should simply support public spending and investment, either directly by printing money or indirectly by cancelling the public debts held on their balance sheets. Tempting as this may sound on paper, both economic theory and economic history suggest that such policy choices would end up causing even more economic devastation with soaring inflation and high unemployment. All is not lost, however, as a virtuous circle of positive global policy coordination and growth boosting structural reforms would do much to build confidence and boost growth. Trouble is that there is little to suggest that such a change is forthcoming in the foreseeable future. Indeed, we need a new game in town but this time it must be the governments!

Michala Marcussen, Societe Generale’s Group Chief Economist