“The New Normal” in the Global Economy

“What is needed is not more finance, but better finance.”

—Martin Wolf

“The world has largely exhausted the scope for central bank improvisation as a growth strategy.”

—Larry Summers

In the last few years, the global economy has evolved in ways once deemed highly unlikely, if not unthinkable. It is a phenomenon that continues today and will intensify in the period ahead.? The global financial crisis that shook virtually every country, government, and household in the world in 2008–09 gave way to a frustrating “new normal” of low growth, rising inequality, political dysfunction, and, in some cases, social tensions—all despite massive policy interventions on the part of central banks and transformational technological innovations.

Now this new normal is getting increasingly exhausted. For those caring to look, signs of stress are multiplying—so much so that the path the global economy is on is likely to end soon, and potentially quite suddenly.

As we approach this historic inflection point, unthinkables will become more common and insecurities will rise, especially as it becomes clearer that, rather than transition smoothly and automatically, the current path could give way to one of two very different new roads. The first promises higher inclusive growth and genuine financial stability. But, in stark contrast, the second would see us mired in even lower growth, periodic recessions, and the return of financial instability.

Fortunately, there is nothing predestined about what will come after the exhaustion of the new normal. The road out of the upcoming “T junction” can still be influenced in a consequential manner by the choices that we make, as households, companies, and governments. But to make better choices, we need to understand the forces at play and their likely evolution. There is no better way of doing so than through an examination of the world’s major central banks . . . past, present, and future.

These once-staid, unexciting institutions have emerged as the major and often sole policymakers. Having fallen asleep at the switch while irresponsible financial risk taking went wild, they pivoted to an aggressive intervention mode during the global financial crisis. In doing so, they saved the world from a multi-year depression that would have devastated lives and fueled social unrest.

Sensing that other policymakers were paralyzed by dysfunctional politics, central banks then found experimental ways to keep the global economy on a growth path, albeit a somewhat artificial one, and they did so even though the underlying engines of economic prosperity were yet to be revamped.

Now these monetary institutions are expected to continue producing miracles. But their ability to repeatedly pull new rabbits out of their policy hats has been stretched to an increasingly unsustainable degree.

This central casting role is new and unusual for central banks. For decades, they operated away from the spotlights. The majority of those who cared to follow these tradition-prone and proud institutions—and there weren’t that many outside the rather small circle of monetary economists and policy wonks—saw them as consisting of highly conventional technocrats who quietly worked be- hind the scenes using complex technical instruments.

The establishment of the first central bank goes all the way back to Scandinavia in the seventeenth century, a century that also saw the creation in 1694 of the Bank of England, which is widely viewed as the parent of modern central banking. Despite the demise of the British Empire, the “Old Lady of Threadneedle Street,” as the bank is fondly referred to—after all, it has influenced the design of most other central banks in the world—is still one of the most influential members of this rather exclusive and enigmatic club.

Yet its power and reach pale in comparison to two other institutions: America’s Federal Reserve, the world’s most powerful central bank; and the European Central Bank (ECB), the issuer of Europe’s common currency (euro), which is currently used by nineteen member countries, and is the most advanced component of the region’s historic integration project.

Both these two institutions are much, much younger than the Bank of England.

The Fed was not set up until 1913, in response to financial turmoil. Today, as the central bank of the fifty American states and the territories, and operating under delegated authority from Congress, the Fed has a mission to “provide the nation with a safe, flexible, and stable monetary and financial system.”

The ECB became operational in 1999. Working with national central banks that are also part of the Eurosystem, its goal is to maintain price stability, safeguard the common currency, and supervise credit institutions (predominantly banks).

To pursue their objectives, all central banks are empowered to manage the country’s currency and money supply with a view to delivering specified macroeconomic objectives—universally, that of low and stable inflation, as well as, in some cases, high central banks have also been charged with supervising parts of the financial system and ensuring overall financial stability.

At the most basic level of their operations, central banks control the price and amount of money in circulation, whether directly (by altering the interest rates they charge banks and the amount of credit that banks are allowed to create) or indirectly (by influencing the risk appetite of the system and its overall financial conditions). In doing so, they have been granted over time greater operational autonomy from their political bosses.

Acting directly or through a parliamentary process, governments set the macro goals for central banks. Many are then left alone to pursue the objectives using the instruments of their choice. This process has been generally viewed favorably as it insulates central banks from short-term political adventures by governments whose eyes are on their reelection prospects. And the related power and influence of central banks have grown by leaps and bounds.

Take the Fed as an illustration. Like other central banks, it has experienced a dramatic increase in its to-do list, tools, and influences—from something as simple as becoming the sole issuer of the currency to much more complex management and regulation of the banking system. Specifically, and to quote from its mission statement posted on its website (https://www.federalreserve.gov/aboutthefed/mission.htm), the Fed is now responsible for:

• conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates; ?
• supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers; ?
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; and ?
• providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system.

Despite this notable expansion in responsibility, might, and impact, nothing prepared central banks for the dramatically unprecedented conversion that they have gone through in the last few years—both during the global financial crisis and in its aftermath.

Forced out of their mysterious anonymity and highly technical orientation, central banks have been dramatically thrust into the limelight as they have become single-handedly responsible for the fate of the global economy. Responding to one emergency after the other, they have set aside their conventional approaches and—instead—evolved into serial policy experimenters.

Often, and very counter-intuitively for such tradition-obsessed institutions, they have been forced to make things up on the spot. Repeatedly, they have been compelled to resort to untested policy instruments. And, with their expectations for better outcomes often disappointed, many have felt (and still feel) the need to venture ever deeper into unknown and unfamiliar policy terrains and roles.

For those accustomed to the conventional operation of economies and financial systems, all this constitutes nothing less than an unthinkable transfiguration for central banks. Yet the structural breaks have not stopped there.

What central banks have been experiencing is part of a significantly broader change whose effects will be felt by all of us, our children, and, most likely, their children, too. It is a change that speaks to much bigger—and consequential—evolutions in the global economy, in the functioning of markets, and in the financial landscape. And the implications go well beyond economics and finance, extending also to national politics, regional and global negotiations, and geo-politics.

Understanding the unplanned and, for them and many others, uncomfortable conversion of central banks from largely invisible institutions to the only policy game in town, provides us with a unique perspective on the much larger changes impacting our world. It speaks to the how, why, and so what by:

• explaining how the global system has fallen further and further behind in meeting the legitimate aspirations of hundreds of millions of people on multiple continents, including those related to economic betterment, remunerative employment, and financial security; ?
• detailing why the world is having such difficulties growing, why countries are becoming increasingly unequal, and why so many people live with this recurrent sense of financial instability and even distress; and ?
• shedding light on why so many political systems struggle mightily just to understand fast-moving realities on the ground and catch up with them, let alone direct them to better destinations. ?By living in this world, most of us have already observed either directly or indirectly a set of unusual, if not previously improbable, changes.

It is a phenomenon that is being felt at multiple levels. And, so far, all this is just the beginning. ?In the years to come, this extremely fluid world we live in is likely to pull us further out of our comfort zones; and it will challenge us to respond accordingly. And we shouldn’t just wait for governments to make things better. ?Unless we understand the nature of the disruptive forces, including tipping points and T junctions, we will likely fall short in our reaction functions. And the more that happens, the greater the likelihood we could lose control of an orderly economic, financial, and political destiny—both for our generation and for future ones.

Mohamed A. El-Erian is the former CEO/co-CIO of PIMCO. He is Chief Economic Advisor at Allianz and member of its International Executive Committee, Chair of President Obama’s Global Development Council and author of the NYT/WSJ bestseller “When Markets Collide.” His most recent book, “The Only Game in Town: Central Bank, Instability and Avoiding the Next Collapse,” is also a NYT bestseller and is available now.

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