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September 17, 2019 - Central Bank Hullabaloo

“Governments with fiscal space should act”

During Mario Draghi's press conference last week, he announced that the Governing Council had made some policy decisions in light of a "continued shortfall of inflation" and indications of "a more protracted weakness of the euro area economy". In addition to cutting the depo rate by ten basis points and restarting the "asset purchase programme", Draghi also gave the markets the vaunted "as long as necessary" assurance a few times. With pushback on negative rates, discussed last week, and doubt about the effectiveness of monetary policy, as we covered in July, there continues to be doubt about central bank potency. On the same day as the ECB's announcement, Gillian Tett of the Financial Times wrote about the "changing zeitgeist" of central bank policy. In "Central banks are rethinking their roles", Tett looks at central bank independence, and in the process, highlights increasing dissent. Phillip Hildebrand, a "former Swiss central bank governor," has pointed out that central bank policy is "so exhausted" and "impotent" that "in the next recession, a different policy framework will be required". Ray Dalio has also voiced his concerns, stating "central banks have now exhausted classical monetary tools" and believes "we are heading for fiscal and monetary policy co-ordination". However, according to Dalio, it is "unclear whether existing government structures will be able to deliver this co-operation smoothly". Even Draghi himself was supportive of an increased role for fiscal policy, saying the Governing Council agreed unanimously "that fiscal policy should become the main instrument" and said, "now it's high time I think for the fiscal policy to take charge".

 Plumbing Problems

Central banks are facing internal and external challenges, at the same time short-term financing markets (where banks turn to meet their residual borrowing and financing needs) are showing signs of "strain". According to an article from the Wall Street Journal, trouble started on Monday and "bids in the fed-funds market on Tuesday morning reached as high as 5%", well outside the Fed's target range of "2% to 2.25%". In response, the New York Fed stepped in and conducted "an overnight repurchase agreement (repo) operation" for "up to an aggregate amount of $75 billion". After some "technical difficulties" caused a delay in the repo operation, the Fed "put $53 billion of funds back into the banking system". "Shortages of funds for banks" were to blame for the proximate spikes, which stemmed from corporation tax payments, heavy bond issuance and the US Treasury's attempts to build its cash balances.

While an analyst interviewed in the article believed the NY Fed's operation "is in every way, shape and form an emergency measure", the St Louis Fed published research in March, as we discussed, covering the merits of a standing repo facility. As of writing, the overnight rate was still well above the Fed's target rate, but there is another repo operation scheduled for tomorrow. So, while the first attempt may have failed, the Fed appears willing to try, try, try again.

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