Central Banks are the hubs of monetary policy. They strive to ensure that the economy and the currency are stable, and that inflation is properly managed. Due to their key value to the world economies and markets, it is vital that they maintain a strong and unwavering image. However, recent developments have taken place that seem to compromise the standing of the central banks, as pointed out by PIMCO CEO Mohammed A. El-Erian.
Mohammed A. El-Erain has provided insight into a worrisome trend that had occurred in the late 1980’s, a trend of which has had terrible repercussions on the present. It was in the 1980’s that former Federal Reserve Board Chairman Paul Volcker began “branding” central banks when he had increased their autonomy and given partial independence from political constraints. With such a move, central banks became known as powerful and responsible institutions that were greatly reliable. Luckily, for a period of time, central banks were able to deliver on that image. That period of time came to an abrupt halt when economic crisis and instability began to materialize in the world economy.
While central banks were able to use their brand to drive their behavior, the economic crisis soon toppled their image. As El-Erain has pointed out, “Western Central Banks have had to confront market failures, fragmented financial systems, clogged monetary-policy transmission mechanisms, and sluggish growth in output and employment.” This has had devastating effects on their image, as central banks thus became even more unable to deliver on their desired outcomes. The overall results of such events, nearly all of which were out of the central-bank’s control, is that banks must find a way to better manage their image. As El-Erain explains, “Western Central Banks need to become more vocal and, one hopes, more pervasive in placing pressure on politicians and other policy makers, Otherwise, risking major brand damage, they will end up adding yet another item to an already-overloaded plate of challenges for the next generation.”
Apart from commentating on the issue of central banks, El-Erain has also provided beneficial input on developments regarding risk assets stating, “The Fed can’t get to its economic objective without going through the asset markets. So the Fed is obligated to continue to support the asset markets, not as an end in itself, but as a means to an end.” Such objectives were also outlined by Janet Yellin, who was recently confirmed as the Head of the Federal Reserve. This may bring good for risk assets, which have recently been identified as having a shrinking safety margin. With the Federal Reserve’s invested interest, risk assets may see increased protection. However, as of now, risk assets are still associated with a diminishing safety net, meaning that investors must be far more careful in how they trades them.
Furthermore, despite all the discussion surrounding asset risks and the Federal Reserve’s involvement, El-Erain has brought up a number of excellent points. While the developments are innovative, there are a great deal of questions that must be answered. El-Erain has pointed to unanswered questions such as, “When do you taper, how do you taper, how do you communicate, what do you do with cost and risk?” These questions only highlight how non-trivial Federal Reserve involvement in asset risk actually is.