Start with a then-and-now comparison.
When the global financial system nearly collapsed about a decade ago, the world’s major central banks launched a series of aggressive countermeasures, including trillions of dollars worth of asset-buying.
The global economics team at Bank of America-Merrill Lynch (BofAML) - in a report that argues central banks are not currently capable of responding to a new crisis - calculate that from 2006 to 2009 the five major central banks cut rates by an average of about 350 basis point.
Could they do that now? Short answer, no.
BofAML reckons the current average nominal policy rate is just 50 basis points, with the European Central Bank and Bank of Japan in particular at the bottom limit of what they can do.
It is not the first time this concern has been raised.
The Bank for International Settlements, often called the central banks’ bank, fired a warning shot two years ago.
“In some jurisdictions, monetary policy is already testing its outer limits,” it said in its 2014/2015 annual report.
In the same vein, Stephen King, HSBC’s senior economic adviser, has noted that in all US recessions since the 1970s, the benchmark Federal Reserve interest rate has fallen by a minimum of 5 percentage points.
It is currently at a range of 1 percent to 1.25 percent.
Similarly, central banks have been buying up the shop since 2008, when the financial crisis hit and the Great Recession began.
Between them, the US, Swiss, British, Japanese and euro zone central banks have balance sheets - essentially cash and asset holdings - totalling roughly $15trillion.
That compares with only around $4trillion at the start of 2008.
They could and probably would expand this in a crisis; central banks have shown great innovation in the past. But with the store of assets available to buy dwindling as a result of the $15trillion, any expansion would have to be far broader.
Doable, but relatively untried and possibly politically difficult.
Despite the huge monetary largesse, inflation remains low and well below target in all major industrialised economies bar Brexit-hit Britain - and even there it may be easing back because of the ebbing of base effects from sterling’s fall.
This means central banks such as the Fed, ECB, Bank of England and Bank of Japan are all making noises of varying hawkishness without necessarily having solved their main problem.
The Fed has already started tightening and is talking about cutting its balance sheet, the Bank of England is at least thinking about raising rates, and the ECB is hinting at tapering its asset-buying.
Even the Bank of Japan, or some members, have been quietly retreating from its radical monetary experiment.
Ironically, it is this desire to normalise that some economists believe is the main risk for global economic growth and for the next downturn.
“In the past, some recessions have been caused by central banks acting too aggressively,” Sarah Hewin, chief European economist at Standard Chartered Bank, said, adding her firm did not see any sustained inflation pressures to rationalise tightening.
BofAML economists Ethan Harris and Aditya Bhave go further, saying central banks should prepare for the next recession by keeping the taps open to overshoot their inflation targets, not make do with bumping up close to them.
In other words, let inflation spike, then tighten.
What, then, if a downturn hits first, before normalisation of monetary policy?
Innovation. The idea of “helicopter money” has already been floated, involving anything from direct transfers to the private sector to monetising government deficits by direct bond sales between government and central bank.
Then, there is always the government itself, opening up its own purse.
“There will be greater need for a fiscal response, as monetary policy alone will not be as effective,” said Leila Butt, senior economist at Prudential Portfolio Management Group.
Central banks can’t do everything, especially when they have already been doing it for close to a decade. - Reuters