Pushing on a string — central banks in the game of confidence

Published August 15, 2019, 12:21 AM

by Charissa Luci-Atienza & Bernie Cahiles-Magkilat




In our last four columns, we drove home the point that the Philippines has demonstrated its capacity to grow beyond its historical ability. This is not exactly a vacuous commentary because this is supported by more than 20 years of strong, resilient economic growth, courtesy of policy reforms in the last quarter of a century. There have been remarkable gains in efficiency, total factor productivity and labor market dynamics. If the trappings of economic growth could mitigate distortions in the sharing of income and wealth in this country, we shall definitely see more sustainability in and more self-sustaining economic performance.Stronger collaboration between Malacañang and Congress is crucial to keep the momentum.

There is another critical element in promoting macroeconomic stability beyond fiscal policy. This is no other than appropriate monetary policy of central banks.

But monetary policy has arguably failed in recent years to stimulate growth in the US economy, the biggest and the most important trading and investment partner of virtually every economy — whether advanced, emerging,  or developing. Flooding the economy with so much money did not work to get people to spend more and companies to invest capital to create growth. Despite the US Fed rate cuts, confidence in the US economy continues to drop, demand for gold rather than US dollar is climbing up. It would not be too remote to see once again capital being pushed out of the US despite the rate cut bug having bitten many central banks around the world.

At one extreme, some would argue that central banks cannot create demand by easing monetary policy.

This is the essence of what FDR and Harry S. Truman’s US Fed Chairman Marriner Eccles described as “pushing on a string” when central banks attempt to talk up domestic demand by cutting rates or reducing required reserves in a period when one, lack of growth is driven by deficient public spending and sluggish external markets; two, cost of money has been at historic lows; and three, public confidence in the economy’s prospects is being diminished. Eccles predated and later was a strong supporter of Keynes’ deficit spending.

The sad reality is that real products and services must be produced. Production is encouraged when people buy more products and services, when companies invest and produce more in response to consumer behavior, when governments spend more on infrastructure and other public services and in the process, employ more workers to deliver public goods to the citizenry and finally, when foreign markets buy the country’s goods and services. More money can help promote production but it cannot produce. Central banks can just move the money around to make production possible by keeping money accessible to entrepreneurs or risk takers in the economy. But when sentiment is down, more money going around may not be enough to motivate people to spend, invest and produce. Fundamentals become less important.

David Rosenberg, formerly of Merrill Lynch, now of Gluskin Sheff, pointed to some tell-tale signs of the divergence between markets and the real sector. US capital expenditure plans are slowing down while home sales are weakening despite — guess what — lower interest rates. In his tweets and other writings, Rosenberg was more pessimistic about the prospects of the global economy even citing the role of demographics. Consistent with this emerging view, we have seenreports recently that global banks like HSBC, Barclays, Société Généralé, Citigroup, and Deutsche Bank laid off some 30,000 employees as investment climate dims and interest rate cuts force the banking sector to downsize.


Having worked at the BSP for more than 41 years and with colleagues from other central banks around the world, I can say with all conviction, that when monetary policy is decided in their respective boards, a significant amount of time is spent on discussing the matrix of risks and their probabilities to growth and inflation. The major risk nowadays is fear, nervousness. The market is jittery over the prospects of the US-China trade tension. Of what Trump is going to do next. And what China has up its sleeves. Trump’s charge of China being a currency manipulator did not help. China helped the tension to escalate by allowing the exchange rate to fall below the magic 7.


While people talk about the positive fallout of investments pulling out of China in terms of hosting them in Vietnam, Cambodia, and even in the Philippines, these positivities can just be zeroed out when these two big elephants in the room finally square off.


It’s almost a zero-sum game that its dire economic implications should be very well known to both parties. But when one drills down and considers the political and security dimensions, the behavior of US and China appears understandable. Those dimensions being the driving force of this fight, the global economy is the collateral victim, market sentiment gets darker and central banks’ attempts to arrest the slowdown could be very marginal.


The way forward is to go back to fundamentals. In emerging markets, including the Philippines, monetary policy could still eke out some more oomph given the disinflationary trend in recent months and the slowdown in growth. Focus should remain on stimulating domestic demand from consumption, private investment, and government spending. With very weak external prospects, capital allocation should continue to be very efficient, avoiding excessive debt-supported expansion. Total factor productivity should continue to receive turbo charge from sustained policy and market reforms to inspire more indigenous innovations on digital platform that we are seeing today, especially in the payments area.





In short, we need to see more domestic offsets to negativities in the external trade account of which we have very little or no control at all. We need to see more production in the real sector rather than more money going around because when the market and the real sector fail to converge, inflation pressures start to build up, risks are mispriced with very low interest rates, and financial stability risks emerge.


What domestic and foreign investors should therefore be seeing are indicators that would inspire rather than discourage investment, expand rather than contract exposure in the domestic economy. Growth will be more sustainable, inflation will remain low and stable, government will run stronger finance, and banks will continue to be strong and resilient. The name of the game should be confidence rather than fear.


In the Philippines and elsewhere, central banks have so much to play in this game of confidence.


Financial Times’ Rana Foroohar ran an interesting column last Monday, August 12 on what Ulf Lindahl, chief executive of AG Bisset Associates, called “summer of fear.”