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Larsen: Central Banks Have Had “Tremendous Success” In Hard Times

Central banks in the developed world could do even more to tackle the “difficult” macroeconomic outlook by keeping interest rates low and injecting money into their economies, Jens Larsen said at Chicago Booth’s Economic Outlook 2013 in London.

Larsen, managing director and chief European economist at RBC Capital Markets, said the outlook for the economies of the US, UK, eurozone, and Canada was for lower growth for longer.

He said central banks had responded with expansionary monetary policy by both cutting interest rates and using their balance sheets to keep rates low across the credit spectrum.

“This has enabled highly indebted governments and households to sustain growth,” he said. “In many ways it has been a tremendously successful policy. Central banks can do more than they ever thought they could and can certainly do a lot to face the challenges we currently face.”

Larsen said central banks had kept inflation expectations stable despite taking these extraordinary measures. “Stable inflation expectations are the best measure I can think of for central bank credibility. If you do that, then all the rest of it doesn’t really matter.”

Focusing on the eurozone, he said the pledge by the European Central Bank (ECB) last summer to buy the bonds of struggling peripheral economies had convinced investors that it would not let any country go “belly up.”

“The ECB has provided us with a salutary lesson of what can be done,” Larsen said. “The aggressive attitude of the ECB over the last year has been the key story.”

However, he said the lack of credible action by member states on fiscal policy had prevented the ECB from acting earlier, although he acknowledged there had been recent “substantial progress” towards political and banking union.

“The progress on the political front in Europe that we have had over the last year has been absolutely essential,” he said.

So far the ECB has concentrated on providing liquidity rather than embarking on outright purchases of assets, as the Bank of England has done through its quantitative easing program.

Larsen said the ECB had room to launch an asset-purchase program while maintaining stable inflation expectations. “Talking to senior staff at the ECB and listening to [ECB President] Mario Draghi, I think there has been a very significant change in the mindset of the ECB,” he said.

He said investors should not underestimate the impact of the change of leadership at the bank made by the appointment of Draghi and the people around him. “People do make a difference,” he said. “It is more a central bank and less a political body.”

Larsen said central banks will face a thorny challenge in the future when they seek to withdraw the money they have pumped into their economies. “The credibility of the central banks rests on being able to do that.”

Phil Thornton