When the next recession strikes, what options will central banks have?
“As the last few monetary-policy cycles have shown, even if the Fed can get the equilibrium rate back to 3% before the next recession hits, it still will not have enough room to maneuver effectively,” according to Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates. “Interest-rate cuts will run into the zero lower bound before they can have a meaningful impact on the economy.”
And when that happens, Roubini says the Federal Reserve and other major central banks will be left with just four options, each with its own costs and benefits.
In a column on Project Syndicate, Roubini weighs these four options and what he calls the “new abnormal in monetary policy.”
“When the next recession strikes, central banks in advanced economies will have no choice but to plumb the zero lower bound once again while they choose among four unappealing options,” Roubini writes. “The choices they make will depend on how they weigh the risks of bloating their balance sheets, imposing costs on banks and consumers, pursuing possibly unattainable inflation targets, and hurting debtors and producers at home.”
Here are the four options central banks will have in the next recession, according to Roubini.
1. Central banks could restore quantitative- or credit-easing policies, by purchasing long-term government bonds or private assets to increase liquidity and encourage lending.
“But by vastly expanding central banks’ balance sheets, QE is hardly costless or risk-free,” Roubini says.
2. Central banks could return to negative policy rates — as the European Central Bank, Bank Of Japan, Swiss National Bank and some other central banks have done — in addition to quantitative and credit easing, in recent years.
“But negative interest rates impose costs on savers and banks, which are then passed on to customers,” writes Roubini.