Former Federal Reserve chairman William McChesney Martin once famously said that central banks should "take away the punch bowl just as the party gets going". UBS Chief Economist Paul Donovan asks if this is really happening right now.
The Federal Reserve is expected to tighten policy further this year. Meanwhile, the European Central Bank (ECB) is expected to announce further quantitative policy moderation. So is the punchbowl being taken away?
The suggested policy tightening is modest. Real (consumer price inflation) adjusted policy interest rates are negative in the Euro area and the US. Real rates are much lower than their post-crisis average in the Euro area, and near average in the US.
Originally, quantitative policy easing met a surging demand for liquidity in a world terrified of credit. As that fear has faded central banks can afford to tighten quantitative policy without anyone going thirsty. Tightening to match cash supply with cash demand is appropriate.
So the punchbowl is being diluted rather than taken away. Moreover, there is no sign the party is getting going. US and Euro area growth are mid-cycle in nature. There is little evidence of the excessive imbalances that signal the excesses of a wild party. The economy is the equivalent a sedate afternoon tea dance. The proposed tightening is similarly tasteful. This is the Downton Abbey of policy tightening.