The crisis is over. The challenges for central bankers are only beginning.

August 24, 2013
Ben Bernanke wasn't in Jackson Hole this year. But the question of how to the global central banks through the post-crisis era very much was. (Andrew Harrer/Bloomberg News)
Ben Bernanke wasn't in Jackson Hole this year. But the question of how to the guide the global central banks through the post-crisis era very much was. (Andrew Harrer/Bloomberg News)

JACKSON HOLE, Wyo. - Each August for the past several years, a conference room on the third floor of the Jackson Lake Lodge here has been stocked with financial data terminals, secure phone lines and all the other accessories that Ben Bernanke and
his top lieutenants at the Federal Reserve might need to fight a global financial crisis.

Many of the world's leading central bankers were back at their annual economic symposium here this weekend. But the conference room is empty.

The crisis, which started in subprime U.S. mortgages six years ago, engulfed banks on both sides of the Atlantic, brought the worst recession in generations and drove several European countries to the brink of bankruptcy, is for practical purposes over. It is over in no small part because the central bankers flooded the world with trillions of dollars and insinuated themselves into countless markets, taking once-unthinkable steps to steer the financial system from the abyss.

The question now for the global economy, and the men and women who guide it, is this: What have you wrought?

The central bankers' years of activism have been more successful at getting the financial markets on track than generating a true economic recovery in the United States and most western nations.

Their institutions, which prize their independence from politics, have found themselves more intertwined with elected leaders than ever: Witness the European Central Bank pledging to stand behind the finances of that continent's nations, or the Federal Reserve's deeper role overseeing the financial system following Dodd-Frank legislation.

And there are growing signs that the unwinding of the banks' trillions of dollars in interventions could be every bit as dangerous and volatile as the conditions that led them to take the actions in the first place. The mere hint that the Fed will slow the rate at which it injects new money into the system by buying bonds has driven a torrential sell-off of all sorts of assets this summer, driving U.S. interest rates up a full percentage point and prompting even bigger financial convulsions in emerging nations like India and Brazil.

"The biggest bubble of them all," said Vincent Reinhart, chief economist at Morgan Stanley, "has been the bubble in central banking."

Only six years ago, there was a general agreement as to what role these powerful, secretive institutions should play and how they should influence the economy. That understanding has been called the "Jackson Hole Consensus" because it reflected ideas
arrived at in no small part at the economic symposium held in Grand Teton National Park every August, sponsored by the Kansas City Fed. The latest symposium concluded Saturday.

Among the elements of the consensus: Central banks should aim, above all else, to keep inflation low and stable. They ought to cut interest rates to combat recession, hike interest rates to cool off booms. They operate independently from politicians. The financial system could be counted on to behave reasonably well, and the occasional crisis could be dealt with by cleaning up any economic wreckage using interest rate cuts.

It is a consensus that has unraveled since the collapse of Lehman Brothers almost five years ago. Since cutting its main interest rate to near zero in late 2008, the Fed has engaged in multiple rounds of "quantitative easing," buying bonds using newly created money; the Fed now holds $3.7 trillion worth of assets, up from $800 billion five years ago. The Bank of England, Bank of Japan and others have adopted similar strategies. The central banks have also undertaken various forms of "forward guidance," essentially telling the markets what they plan to do in the future to try to improve conditions and boost financial markets today.

And governments, in trying to tighten financial regulation, have assigned the central banks ever more responsibility for cracking down on banks that rely on too much borrowed money or on markets that emerge out of nowhere to put the global economy at risk.

The result of all this is central banks that are more intertwined with politics, whether it's the Fed owning large volumes of home mortgages, acquired through QE policies, or taking a deeper role regulating the financial system.

"We're not going back to the pre-crisis world anytime soon," Glenn Hubbard, the dean of Columbia Business School, said in an interview. "I'm not saying the Fed shouldn't have done it. But a lot of it does raise a gray area of what should be Congress's
job."

One recurring theme in the discussion at this year's conference was that the actual benefits of these strategies, almost five years later, are still uncertain. One paper, by economists Arvind Krishnamurthy and Annette Vissing-Jorgensen, found that the Fed's
purchases of Treasury bonds had done little to help spur growth (their analysis was more supportive of parallel efforts to buy mortgage backed securities).

Even those who have been architects of these strategies expressed concern that, with the global economy in the dumps for so long, they may be running out of room for effectiveness.

"It is a policy best suited to filling in a temporary hiatus in demand, not a long-lived shortfall," said Bank of England deputy governor Charles Bean of quantitative easing in an address to the conference. "It is a bridge, not a pier."

At the same time, as the prospect of ending the era of central bank interventionism comes into sight, risks are emerging that unwinding the programs will cause a new wave of problems. With ultra-low interest rates in place in most of the advanced, wealthy nations, investors have plowed money into emerging economies like Mexico, Brazil and India to earn higher returns.

Now, the prospect of an end to the era of easy money is drawing that tide of money back out, leaving those nations with currencies falling sharply and interest rates spiking. The governor of Brazil's central bank was scheduled to speak at the conference
but canceled at the last minute to deal with the burgeoning financial problems. His deputy, along with Mexican central bank governor Agustin Carstens, urged leaders of the Fed and other western central banks to keep in mind the impact of their actions
on other nations.

"It seems clear that one of the hallmarks of the post-crisis period is a recognition of the interconnectedness of the global economy and financial system," said John Lipsky, the former No. 2 of the International Monetary Fund and now a professor at
Johns Hopkins' School of Advanced International Studies. "It strikes me as hard to conceive that you can successfully manage focusing on your own domestic performance without being able to take into account what is happening abroad."

A new cast of characters is taking charge to address these challenges, including new governors at the Bank of England and the Bank of Japan who took office this year. But the big one is yet to come: Ben Bernanke is expected to step down when his term as Fed chair ends in January, and the Obama administration has spent the summer wrestling with whom to appoint to succeed him. (Larry Summers is now viewed by Fed watchers as the front-runner, with vice-chair Janet Yellen and former vice-chair Donald Kohn also in the running).

But in many ways, the president's opportunity to guide how the Fed will address the challenges of a post-crisis era is bigger even than the looming vacancy at the top would suggest. Of the seven-member board of governors, one is stepping down at the
end of this month (Elizabeth Duke), another has been appointed to be deputy treasury secretary (Sarah Bloom Raskin) and a third has a term that expires in January (Jerome Powell). Yellen's term as vice-chair ends in October 2014, and she may well retire at that point if not named chairman.

"The president has an opportunity to reshape the Federal Reserve," said Morgan Stanley's Reinhart. "It's not just who he appoints as chairman, but the different governors and the mix of skills they bring to the table. With the challenges they're facing, it's going to have to be a group effort."

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