Unconventional tools deployed by central bankers from Frankfurtto Washington to mitigate the economic fallout of the financialcrisis may be conventional when the time comes to combat the nextdownturn.

The Federal Open Market Committee (FOMC) is already discussingthe issue while other central bankers and economists in developednations debate whether to holster emergency policies—bond buying,targeted credit programs, and negative interest rates—or make thempart of their everyday armories.

The shift beyond a short-term interest rate as the main lever ofmonetary policy could force investors, consumers, and businesses tomake sense of a world with multifaceted, sometimes arcane policies.Toolkits expanded since the crisis seven years ago are encounteringresistance from lawmakers and others who argue central bankers havegone beyond their mandates.

“I really wish we would stop yielding the ground and acting asthough these policies are something to be ashamed of or somethingto abjure except under emergencies,” Adam Posen, president of thePeterson Institute for International Economics in Washington and aformer Bank of England official, said at an IMF forum thismonth.

Policy makers are facing tough choices because of the unusualnature of the recovery across the developed world. Despite morethan 600 interest-rate cuts and more than US$12 trillion inasset-purchases, inflation rates remain well below the targets ofmost central banks and the speed at which economies can expandseems to have downshifted because of aging populations anddeclining worker productivity.

Such an environment also means rates will likely peak lower thanin past cycles and the return to zero will be faster, said MauriceObstfeld, the International Monetary Fund's new chief economist.“The risk is that when the next recession comes we will be at a lowlevel of nominal interest rates so there is not a lot of ammunitionto respond,” Obstfeld said in an interview.

Federal Reserve officials last month made the same point, sayingthe policy rate that is likely to keep the economy humming at fullemployment and stable prices “would likely be lower than was thecase in previous decades,” minutes from the Oct. 27-28 meetingreleased Wednesday showed.

“The question is, 'What can monetary policy do about that?'”Obstfeld said.

The obvious answer for many central bankers and economists is tostart promoting unconventional tools as part of the range of normalpolicy choices for the future.

Switzerland and Sweden have already proved it possible to cutbenchmarks beneath zero without triggering bank runs or cashhoarding, while even the European Central Bank (ECB) may next monthcharge banks even more to hold their cash overnight.

Fed officials are expressing their interest in the issue, withthe minutes noting “it would be prudent to have additional policytools,” according to some at the meeting.

On the other side of the debate, economists such as MarkCalabria, director of financial regulation studies at the CatoInstitute in Washington, say the Fed should begin a conversationnow with fiscal policy makers about the limits of interest-ratepolicy so they don't engage in an ever-expanding array of unusualtactics.

“If you want to protect the independence of monetary policy,then the Fed chair should be vocal about where the line is, whatyou can fix, and what you can't,” Calabria said.

Turning the unconventional into the conventional is not assimple as it sounds, said Michael Bordo, an economic historian andprofessor at Rutgers University, who noted that the new policiesare “worrisome” and carry their own set of risks.

For one thing, they create winners and losers. Savers, forexample, could lose out from monetary largesse and negative rates,while bond holders and property owners are rewarded. Easy money ona prolonged basis could also end up inflating assets more than theydo the real economy, risking financial instability as investorscreate bubbles in the hunt for returns.

Such bubbles also tend to favor asset holders over wage earners,breeding controversy. Bank of America Corp. estimates an investmentof $100 in a portfolio of stocks and bonds since the Fed beganquantitative easing would now be worth $205. Over the same time, awage of $100 has risen to just $114.

Lawmaker Scrutiny

“It is not surprising that we have gotten a lot of scrutiny, andI am not surprised at all about the populist anger,” Richmond FedPresident Jeffrey Lacker told reporters last week.

Unorthodox monetary policies can also look a lot like fiscalpolicy boosting specific sectors of the economy, drawing theinterest of politicians. The Fed currently owns $1.74 trillion ofmortgage-backed securities, intended to help keep borrowing costslow to boost the housing market.

In the U.S. House of Representatives, Republicans are skepticalabout the Fed's discretion. Lawmakers in the chambervoted 241-185 on Thursday for legislation that would force theFOMC to describe its policy rule and, under certain conditions,subject their decisions to audits. The White House has threatenedto veto the measure should it reach President Barack Obama forapproval.

In this political environment, more rounds of quantitativeeasing would beget more scrutiny, said Sarah Binder, a seniorfellow at the Brookings Institution in Washington who is writing abook on the Fed and politics.

“The Fed has certainly not restored its political reputationthat it could rely on to insulate itself pre-crises,” Bindersaid.

Central bankers say they are just doing their jobs. They havemandates to keep prices stable, and in the Fed's case, to keepunemployment at a minimum. Recent experience has bolstered theconfidence of some officials that unconventional tools work.

“A number of studies have suggested that the forward guidanceand large-scale asset purchases conducted by the Federal Reserveboosted the levels of employment and inflation at a time when thelevel of short-term interest rates was constrained by the zerolower bound,” Fed Governor Lael Brainard said in a Nov. 6speech.

In Europe, Bundesbank President Jens Weidmann has been among theskeptics even as ECB President Mario Draghi considers freshstimulative measures next month. The effectiveness of “ultra” laxpolicies is wearing off and their risks and side effects aregrowing, Weidmann told Tagesspiegel newspaper this month.

On the other side are some current or former central bankers,who argue that unorthodox policies may have actually been too timidand are the way of the future, like it or not.

“There is no reason to think that you have to give up balancesheet operations or quantitative easing-type operations once youget back to 'normal,'” Posen said.

Obstfeld said both the advocates for rules and those for actionhave sound arguments. Research has shown that discretionarypolicies don't always produce the best outcomes, he said. On theother hand, studies have also shown that use of quantitative easingduring the 2008 financial crisis and subsequent global recessionprobably staved off a deeper slump.

Unconventional tools “are going to stay part of the toolkit,”Obstfeld said. Still, whenever they are used, “there will betensions.”

–With assistance from Alex Tanzi and Vince Golle.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.