A game central banks can’t win Prolonged and excessive reliance on central banks has reduced the power of both conventional and unconventional measures. ‘The hope is to come up with new tools to reverse these worrisome phenomenon MONETARY-POLICY SPECIALISTS ARE furiously exploring ways to improve central banks’ effectiveness, particularly should economies fall into a recession—a risk heightened by the comnavirus’s cascading economic stop.
The underlying B) licy motivation is the growing recognition that prolonged and excessive reliance on central banks has reduced the power of both conventional and unconventional measures; it has even made them counter prod active. The hope is to come up with new to this worrisome and accelerat- phenomenon.
As important as this work is, I am worried that basic misperceptions risk making it unsuccessful when central banks face growing pressures both from within and without. To understand why, let us look at this through the prism of game theory. Key elements of any game—that is, strategic interacti ons between two or more participants include the characteristics of the players, strategies, and payoffs, informati on avail ability and the status of trust, cooperation and rationality.
Good players choose their best strategies understanding what others are todo under a given set of conditions. Outcomes vary from destructive non-cooperative games to so-called hereto optimal ones, in which a player is better off without any Other being worse Off. For years, central banks had domi- nant strategies, using interest rates and forward guidance to press others to respond in ways that helped meet the banks’ economic and financial objectives.
They informed and influenced the behaviour of a broad range of eco- nomic actors and, sometimes, even directly imposed outcomes. This was seen in the smoothing out of business cycle extremes and, most vividly, in overcoming the 2008 financial sudden stop that was on the verge of tipping the global economy into a damaging multiyear depression.
In recentyears, however, the strate- gies of systemically important central banks such as the Bank of Japan, the European Central Bank and the Federal Reserve have not been as effective, with repeated failures to meet one or more Of their stated objectives. This is due in large part to what can be thought Of as changes in game conditions. Central banks appear to haveless of an information edge.
Combined wi th challenged analytic al models, this has translated into repeated errors in growth projections, and an underap- preciation of the risk to financial sta- bility because of po&ts of excessive risk-taking among nonbanks, espe- ciallywhen i t comes to liquidi ty risk. Repeated game conditions that once anchored central banks’ now threaten to expose more short- comings relative to objectives. No won – der central bank strategies are transi – tioning fmm “dominant” to “dominated,” especiallywith respec t to that now feel more empow- ered to force the banks’ policy hand. Policy adaptations under discussm to i nflation expectations range fmm expandi ng the use of unconven – tional policies to raising objectives— both directly and through flexible inflation targeting. Unfortunately, the first is a troubling sign of active iner- tia—realising that something different is ne«led yet doing more of the same.
MOHAMED A EL-ERIAN Bloomb erg The fails to counter the strong disinflationary effects of struc – tunl changes to the economy and demand deficiencies. More out-of-the-box adaptations i nclude making monetary policy sub- servient to fiscal stimulus and directing central banks to pursue so-called helicopter money or people’s QE, which provide direct cash handouts to large segments of the population. Even if shown to be technically and politically feasible, these carry high risks of collateral damage and unintend ed consequences. This difficult quest for a magical solution may well indicates a more crit- iCal issue: an incorrect analytical framework By the very nature of their construct and role in a modern econ- omy, central banks are poorly equipped to turn around what leads to persistently low demand and productivi ty.
Continuously ignoring this inconvenient truth only serves to undermine their institutional integrity and credibility. The solution but it is in the hands of other policy-making bodies that need to directly address issues such as labour training and retooling, i nequali ties and fiscal i incentives.
Looking for new central bank tools will remain an intellectually interest exercise, but ultimately a futile one if the context is not changed. After all, let us not forget Brian Christian and Tom Griffi ths’ s simple yet powerful insight: “Well, if the rules of the game forces bad strategy, maybe we should – nt try to change strategi es. Maybe should try to change the game”