Central Banks Try to Stave Off Recessions – 1/20/16

Credit-driven growth has been used by central banks to counter weak economic conditions for decades but as Chinese officials attempt that cheap loans have lost their impact and interest rates are already near zero for the US and many other countries, the limits of the approach are becoming apparent.

The United States, Europe and China are the best examples of how central banks are facing different challenges.

Should another recession hit the US, the Federal Reserve will have to get creative with policy. A deadlocked Congress unable to reach agreements on spending bills is not likely to be much help on long-run cures for the pressing issues like baby boomer retirements or modernizing infrastructure or investment in education. And with populist presidential candidates further polarizing political debate, the situation is not likely to change during the election year.

In Europe, the ECB is attempting keep Europe’s economy on track in spite of its inability to institute the large-scale economic reforms needed to combat jobless rates averaging above 10% and inefficient business regulation. Aging populations combined with generous social benefit programs and high unemployment are likely to drag down economic prospects if nothing is done. Unfortunately, Europe is also seeing the rise of right wing political groups threatening already weak coalition governments. The refugee crisis is likely to be the main issue for most nations for some time.

While the Western governments struggle internally, China’s leadership is attempting to prove that it can guide the country through its recent economic turmoil. The government must prove itself capable of effective management after missteps in managing stock market routs and an apparent slowdown in China’s explosive growth rate. Unlike the Federal Reserve, the People’s Bank of China still has room to lower interest rates with benefits from the easing going disproportionately to large state-run companies.

After years of stimulus, the loose lending has generated less growth as loans go to paying staggeringly large interest payments. The central bank cut interest rates in the past to spur growth but overcapacity in real-estate and industrial production has made that option unattractive.  Many even fear that further credit easing would only lead to asset bubbles and increased capital outflows. The official Chinese strategy currently involves shutting down inefficient companies and restructuring the economy to focus more on higher quality goods and services. Unrest is expected to follow the job losses cause by the pivot towards industries with more sustainable growth.

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