The Great Escape

Estimated reading time: 2 minutes

Many other central banks are still fretting about low inflation, despite signs of recovery or asset-price inflation. But high debt levels mean keeping real interest rates low to support deleveraging. So this time, most developed-world central banks are likely to head in a different direction from the Fed.

So overall we expect a continuation of the global expansion, albeit at a weak nominal rate. But what if even a very gradual Fed tightening cycle, while other banks ease, still means disappointing US and global growth? There are still policy options, but they are limited.

Rate increases can be reversed, but the Fed typically cuts by 0.5 per cent in response to recession. Quantitative easing could be expanded, despite the signs of diminishing returns, and negative rates may become more widespread. But monetary policy is nearing its limits and there is an increasingly strong case for fiscal policy.

If the outlook deteriorates further, governments could step up borrowing at very low bond yields, lifting spending without crowding out the private sector. But the higher spending must be in areas that raise medium-term supply potential through, for instance, more infrastructure and R&D.

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