The Only Game in Town by Mohamed El-Erian provides a snapshot of the unusual situation central banks found themselves in after the global financial crisis of 2008. In order to avoid a catastrophic worldwide financial meltdown, Central Banks around the World acted as lenders of last resort and embarked on ambitious quantitative easing programs to stabilize the markets and revamp economic activities.
The banks went into uncharted territory by over-reaching into different parts of the economic systems and finding themselves at the center of the global economic stage. If it is true that Central Banks saved the World from a financial collapse, at what cost did they do it?
The main argument, reiterated by many experts and practitioners today (the book was written in 2016 but its main takes are still valuable at the time of writing), is that while Central Banks indeed prevented the financial World from collapsing, they fostered growing inequalities by artificially pushing up asset prices and might have increased complacency in financial markets, which now depend heavily on the action of the Central Banks (especially the Federal Reserve and the ECB).
This in turn might lead investors to take on more risk, knowing that the Central Bank will be ready to intervene in case of a downturn, thus increasing the so-called “moral hazard” problem. Moreover, by suppressing each small burst of volatility, Central Banks might be postponing a big burst in the future by letting pressure and inefficiencies mount up in markets that are now artificially low in volatility.
These inequalities and market inefficiencies also risk causing a political backlash, which the World was starting to observe at the time this book was written (2016). Another issue is the divide between political partisanship and personal interests and the economic long-term benefits of the nation-states. Starting from the United States and its inability in passing laws, the author explains how bad politics can severely hinder the positive effects of economic reforms and the actions of the Central Bank itself.
Indeed, as observed in Italy from 2009 to 2019, the favorable action of the European Central Bank, which bought large amounts of Government and Corporate Debt pushing yields down, was not followed by virtuous fiscal policy on the part of the Government, which instead kept on borrowing to funnel funds into inefficient expenditures and clientelism (this is a cautionary tale for Emerging Market economies like the Philippines).
Mohamed El-Erian (the author) argues that the World is at a t-junction, which means that it can either choose one way or another to go forward. The future outcomes depending on the specific path chosen, one most likely to be very good and one very bad. This concept is explained through the use of a bimodal distribution of outcomes, a distribution with two more extreme likely outcomes than the central value compared with a classic normal distribution (which has the most likely outcome in its central value).
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Authored by: Edoardo Cicchella
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