Next Up for Central Banks: Infrastructure Investments?

In the years following the global financial crisis, the world’s leading economies have found relief through aggressive monetary policy. But with interest rates slashed to historic lows and central bank balance sheets significantly larger as a percent of GDP than they were before the financial crisis, policymakers will need alternatives to interest rate cuts and conventional quantitative easing when the next recession comes along. U.S. central bankers have cut real interest rates between four and five percentage points during previous recessions, but that would be a difficult feat to pull off in today’s world, with a fed funds rate between 0.25 percent and 0.5 percent.   One novel idea is what Credit Suisse analysts are calling fiscal QE, a not-entirely-literal catchphrase to describe expansionary fiscal policy in which central banks play an important role. Credit Suisse has identified several potential flavors of such, ranging from the very likely (coordinated monetary and fiscal policy) to the very difficult, including “helicopter money” policies, in which central banks either buy government bonds with very long maturities to finance government spending or lend to commercial banks at negative rates with a mandate that the banks then lend to consumers and corporations interest-free.   The most feasible form of fiscal QE would seem to be a process through which central bankers team up with policymakers outside their usual monetary policy stomping grounds to facilitate infrastructure spending. Public financial institutions, for example, could issue bonds to fund projects in areas where key infrastructure is sorely lacking. Central banks would buy those bonds and, barring any default, effectively fund stimulus without adding to government debt. But there’s the rub: The strategy will only work if it is used to finance profitable infrastructure projects for which the bonds are not at risk of default. Because if they do, central bankers will find themselves will yet another thing to worry about when it comes to the quality of their own balance sheets. “If defaults are large enough, they might start to undermine the central bank’s capital position,” caution analysts with Credit Suisse’s Global Markets team.   After years of underinvesting in infrastructure, policymakers in the U.S. and parts of Europe at least have plenty of projects from which to choose. As well as a pressing need to do so: The U.S., the United Kingdom, and Germany are currently spending too little to meet “baseline needs” for the next 15 years, according to the McKinsey Global Institute. To close their respective gaps, the U.K. and Germany would each have to shell out approximately 0.4 percent of GDP per year through 2030 – about $11.4 billion for the U.K. and $13.4 billion for Germany – while the U.S. would need to spend an additional 0.7 percent, or some $125 billion, annually.   Credit Suisse analysts believe the economy most likely to pursue infrastructure spending with the help of its central bank is the U.K. That’s at least partly due to the fact that the Chancellor of the Exchequer, a role roughly equivalent to the United States Secretary of the Treasury, wields a larger influence on monetary policy than is typical of his or her foreign counterparts. In January 2009, for instance, it was the Chancellor who directed the Bank of England to establish an asset purchase program. “It is fairly easy to envisage a situation where the Chancellor authorizes the BoE to buy infrastructure bonds issued by, say, a U.K. infrastructure bank,” say the analysts. For its part, the analysts believe that the U.S. is more likely to employ “implicit” fiscal QE through coordinated fiscal and monetary policy rather than more direct Federal Reserve involvement in actual infrastructure funding. In that scenario, the Federal Reserve implements monetary QE at the same time that Congress approves infrastructure stimulus. The goal is the same, the mechanism only slightly different.   The euro area, by contrast, faces more of an uphill battle than either the U.K. or the U.S. in adopting any form of central bank-supported infrastructure spending. And the reason for that is also political: As Credit Suisse’s European economists note, “any political agreement in Europe tends to take time and happen only into a crisis.” One way it could happen is if European officials revamp the Juncker plan, the Eurozone initiative to raise €315 billion for investments, including infrastructure projects financed by bonds issued by the European Investment Bank (EIB). So far, European authorities have approved €12.8 billion for projects which are expected to attract another €80 billion in capital from private sources. Credit Suisse analysts believe the plan would be more effective if the European Central Bank begins buying the EIB’s bonds.   Japan is an outlier among the major central banks in that it is unlikely to pursue central bank-financed infrastructure spending, simply because the country doesn’t have the same pressing infrastructure issues as western nations — prior stimulus projects have already upgraded the country’s infrastructure. But the bank still sees Japan as the most likely to pursue some form of fiscal QE. Instead, Credit Suisse believes Japan will pursue a “helicopter money” policy, with the government cutting taxes and making up for lost tax revenue by issuing long-term debt that the central bank would purchase.