WAITING ON CENTRAL BANKS?

Commodity prices firmed up in April and gave investors another boost of confidence. Stronger commodity prices indicate increased demand, which is a positive sign for both developed and emerging economies. In particular, the price of oil found some support at more than $40 per barrel. Even as the number of active rigs declines, the global oil supply remains mostly unchanged. This is because producers must pump more and more oil to keep their revenues up while the price of oil is so low. We should be close to a tipping point, where production increases are unable to mask the declining rig count and supply starts to fall. As supply comes back in line with demand, we will see oil prices start to rise more steadily. Aside from the news from the commodities markets, central banks were the big story of April, as investors looked to them for guidance as to the direction of the global economy.

Once again, the Federal Reserve (“the Fed”) left interest rates unchanged and analysts were unsurprised. US economic data has been a mixed bag and inflation remains stubbornly low, which means that there was not much pressure on the Fed to tighten its policy. However, the Fed indicated that it expects to raise rates at its next meeting, unless either economic data or global events raise significant concerns. Analysts remain skeptical and they still forecast a longer delay before the Fed raises rates again.

Meanwhile, the European Central Bank (“the ECB”) is facing criticism from German lawmakers for its stimulus programs. As the largest member and strongest economy in the Eurozone, the actions and opinions of the German government hold significant sway within Europe. The ECB acts independently and its mandate is to serve the entire Eurozone, but pressure from Germany will make it harder for the ECB to continue to aggressively pursue its stimulus program.

Germany is in a much different economic position than the rest of the European Union. Instead of struggling with low growth, high unemployment, and large budget deficits; Germany enjoys healthy growth, low unemployment, and a comfortable surplus. Throughout the debt crisis in Europe, Germany refused to raise its spending or make concessions to its indebted neighbors. In fact, you may recall that the German finance minister was the prominent agitator for taking a hard line in the Greek debt negotiations. A country in a strong economic position, like Germany, sees the ECB stimulus program as a detriment to its financial sector, which struggles to turn a profit in a negative interest rate environment, and to its conservative investors, who must turn to higher-risk investments to meet their required rates of return.

This disagreement between Germany and the ECB allows us to look at the two types of tools used to stimulate an economy: monetary policy and fiscal policy. Monetary policy controls the money supply and manages interest rates, and fiscal policy uses taxation and government spending. In an economic union, like the Eurozone or the United States, monetary policy is a blunt instrument. Changes in interest rates or the money supply affect all members at once and cannot be targeted toward those neediest participants. In the Eurozone, the ECB has sole control of monetary policy.

Fiscal policy can be more precise and more powerful, so long as the government’s credit rating is healthy. In the United States, the federal government is able to use spending programs, loans, and tax breaks to incentivize investment in hard-hit areas of the country. In the Eurozone, the central government is much weaker, so fiscal policy is largely in the hands of the individual nations. Unfortunately, the European debt crisis crippled the ability of struggling nations to use fiscal policy, when their credit ratings plunged to junk status. Until the members of the Eurozone agree to work together on a solution, Germany will be frustrated by the ECB’s actions and struggling Eurozone members will continue their painfully slow recoveries.