Central Banks (CB) are again under pressure as the coronavirus increases the risk of a recession. US markets expect/demand 2 rate cuts in the next few months, finally convinced of a U-shaped recovery. They believe in the CB-put that history seems to validate. 1/n
The possible coronavirus recession is first a supply shock and only later a demand one. There are doubts that monetary policy can address it efficiently, but some easing will become necessary. However, in the US, the public debate is too focused on the stock market downturn 2/n
Easing policy now could be seen as a too explicit stock-market-put, given the nature of the recession. So, the FED may hesitate and delay, hoping for the best. In the end, though, it will ease further. 3/n
Naturally, if the markets believe in the policy-put that may lead to a move of “buying the dip” (many times successful), which will mitigate the downturn, reducing but not eliminating the pressure on the FED. “Buying the tip” may be delayed, though, this time 4/n
Monetary policy is not just a game between CB and financial markets. After all, monetary policy transmission goes via credit and financial markets. It is also a big lesson of the crisis that the financial sector and asset price drops can induce real recessions 5/n
Ricardo Caballero has developed a new risk-centered macroeconomic theory that builds on the interaction of the real economy, risky asset markets, and policy-puts “On the global impact of risk-off shocks and policy-put frameworks” 6/n bis.org/publ/work772.p…
The output gap and the risk gap interact, and the need to absorb both is seen as a task for monetary policy. An attractive feature of the approach is that monetary policy is not transmitted via unlimited intertemporal optimisation but via the interaction with financial markets7/n
A very recent restatement is: nber.org/papers/w23614.… A simpler version can be found at bis.org/publ/bppdf/bis… and voxeu.org/article/risk-i…. “the world economy is currently ‘bipolar´..between the current .environment, and a global recession induced by a risk perception spike” 8/n
Policy-puts may, of course, create moral hazard. The theory is also criticised by the BIS, pointing that risk-off shocks are not exogenous but depend on previous lax policies allowing too much search for yield See e.g.Disyatat bis.org/publ/bppdf/bis… 9/n
Will the policy-put one day be extended to the recommendation by @roger_farmer e.g.in nber.org/papers/w22135.… for the CBs to buy equities to stabilise the economy? A proposition that has been received so far with scepticism (not in Japan) 10/n
Europe seems far away from these “anglo-saxon speculations”. The stock market issue is diluted in the public debate in relation to monetary policy. This doesn´t exclude pressure on the ECB, despite recent resilience indicators 11/n bloomberg.com/news/articles/…
Would a yield curve shift by some basis points produce visible results? Is a “gesture” unavoidable in the game with financial markets?Or is it more important the “game” with Treasuries for a bit of necessary fiscal policy?If recession is coming something will have to happen 12/12
