Life Is Getting Harder for Central Banks

For reasons largely outside its control, the Federal Reserve is now being widely blamed for fueling financial market instability and risking derailment of the U.S. economy. This is quite a contrast from just a few month ago, when it was still being feted by many for its role as an active and effective repressor of financial market volatility. It is probably only a matter of time until the European Central Bank finds itself in a similar, perhaps tougher position. The reality is both central banks have entered a new, more uncertain phase that is likely to last for some time, requiring more skillful policy navigation and communication, and some operational changes.

Coming out of the 2008 global financial crisis, central banks went out of their way to boost asset prices as a means of supporting the economy. They suppressed volatility by driving down interest rates; buying huge amounts of debt securities and housing them securely on their balance sheets; and, when a bout of volatility occurred, being quick to reassure markets of their broad and consistent support.