As professional investors, a thought-provoking exercise is to question how a period of economic history might be remembered.
While previous periods in history are known for, say, Keynesian economics or deregulation, how will we recall today’s environment?
One well-known feature of the current economic environment has been an extremely lengthy period of low interest rates, but I believe this is a symptom behind the cause.
I remember the very active and persistent involvement of central banks in financial markets and the scale of their involvement reaching levels that would have been unprecedented before the financial crisis. Their interference has ranged from negative interest policy, yield curve manipulation, to even buying equity ETFs. The scale of these activities and their consequences have put greater focus and pressure on the US Federal Reserve.
In her recent book ‘Fed Up’, Danielle Dimartino Booth, an insider at the Fed, has shed light on the lack of knowledge that the investment world has about the inner workings of central banks and their decision-making processes. While there have been numerous books written by former Fed governors, this book asks every American to “understand this extraordinarily powerful institution and how it affects his or her everyday life and fight back”.
One of the most difficult problems for all central banks to understand is how and on what criteria they should be judged, as they have been deliberately designed to be ‘independent’ from politicians. This makes it complicated for those same politicians to then scrutinise and hold their central banks to account. One of the reasons for independence is to prevent monetary policy being used inappropriately by governments that might be tempted, for example, to print money to facilitate high levels of public spending to remain in power.
Performance goals do exist, such as the inflation target in the UK and the Fed’s dual mandate of inflation and employment. These targets feel too simplistic and it’s hard to hold anyone accountable for the wider benefits or costs to society. I would argue that there is no way of knowing to what extent the Fed has helped or hindered the journey towards the economic outcomes for which it is held responsible. I would also argue that it is very difficult for institutions to be effective when they are not held to account via an effective feedback system.
The Fed’s word is generally accepted within the investment community and its statements are poured over to a degree. My review of interest rate policy acknowledges that the current policy has been positive for debtors and the owners of assets, whose prices have risen considerably in an environment of ‘free money’. I also note the less welcome outcomes for savers with cash deposits, or the populism that has been fuelled by the rising wealth inequality between those with inflating assets and those without.
Regardless of your opinion, I would contend that we should consider the actions of central banks more broadly and hold them more accountable on behalf of ourselves and our clients. The range, scope and impact of central bank activity has now spread well beyond what was envisaged when they were created. The need for scrutiny has never been higher.
Philip Bagshaw is senior portfolio specialist at City Asset Management
