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As a former central banker and head of the Group of 30, Dr. Jacob Frenkel, chairman of JPMorgan Chase International, knows better than most the dangers of exceptionally low interest rates. Tracy Alloway reports.

Doctor Jacob Frenkel is smiling with Alan Greenspan, former chairman of the Federal Reserve. A glance right, and he is sidling up to Jack Ma, chief executive of Alibaba, the Chinese e-commerce giant; look left,

and he’s teaching a former prime minister of Israel how to use chopsticks at a stately dinner. Blink, and he is standing next to George Lucas and Steven Spielberg, two of the world’s most famous film directors.

In his office in New York, row upon row of photos show a cheerful Dr Frenkel mingling with a veritable ‘who’s who’ of the global finance and business elite.

Dr Frenkel may not be as well known as some of his compatriots in the

photos which adorn his office, but for decades he has been a major figure in the world economy, first as two-term governor of Israel’s central bank and then as head of the Group of Thirty (G30), a powerful cadre of economic policymakers and regulators.

Now ensconced as chairman of JPMorgan Chase International, a role that involves representing the banking giant to regulators and clients, he remains perfectly placed to discuss a defining trend of today’s

financial world: the enormous influence of monetary policy on markets.

Here, as Dr Frenkel puts it, “central banks have become the only game in town” by virtue of the trillions of dollars worth of unconventional monetary policies they have collectively unleashed over the past several years.

Unconventional policiesSo when Dr Frenkel smiles again and asks if I want to wager how long central bankers initially thought those unconventional monetary policies would last, I am reluctant to take the bait. Name a central banker, and Dr Frenkel surely knows them, their policies and their innermost thoughts about those policies.

“I’m willing to bet with you that if in 2008 each one of the central bank governors were to put in an envelope his guess on how long they would use unconventional policies, no one would have believed that it would last for over six years,” he says. “What was supposed to be very temporary has become, after several years, much more permanent.”

As a long-time central banker, one might expect Dr Frenkel to take an exceedingly enthusiastic view of the power of monetary policy. Certainly, he has been criticised for his optimism in the run up to the financial crisis and ensuing recession. He famously went head to head with Nouriel Roubini, the economist who is now

Let’s not kid ourselves. Interest rates are the most efficient instrument of monetary policy, period.

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credited with predicting the bursting of the US housing bubble and the scale of its impact.

But the Dr Frenkel I find on a sunny afternoon in August is not the rose tinted glasses-wearing policymaker I expected him to be. Instead he is more than keen to emphasise the limits of monetary policy’s restorative power when it comes to curing the ills of the global economy.

Zero ratesSince the crisis plunged much of the developed world into deep recession, the policy response from central banks has been to drop interest rates to practically zero and then balloon their balance sheets in an attempt to prevent a deflationary spiral.

“Interest rates all over the world have been reduced to very low levels and they have now reached levels that are very close to the ‘zero bound’. As a result, the potent policy measure of a further reduction of

interest rates ceased to be feasible,” says Dr Frenkel. “Policy makers ran out of conventional ammunition.”

While Dr Frenkel says he does not doubt the necessity of these extreme actions in the aftermath of what has proven to be a massive shock to the financial system and global economy, he is surprisingly wary of the legacy these emergency policies may leave.

“Monetary policy has performed extraordinarily important tasks, but we have arrived now at a situation where we must also understand that there are a lot of challenges in front of us,” he says.

Low rates and asset purchase programmes, known as ‘quantitative easing’ or ‘QE’, are supposed to force investors away from hoarding cash and kick start the wider economy, but now there are concerns that years of easy money have pushed markets into frothy territory. Indeed, Greenspan’s era of low interest rates has often been blamed for exacerbating risky investor behaviour in the run up to the crisis.

1991 Jacob Frenkel served as governor of the Bank of Israel from 1991-2000.

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Markets track bankers In more recent years the trend has been for markets to move sleepily in one direction for months until a comment about the potential winding down of the Fed’s QE or a theoretical interest rate rise suddenly shocks them out of their central bank-induced torpor.

Investors of all stripes now hang on the words of Janet Yellen, chair of the Federal Reserve, or Mario Draghi, head of the European Central Bank (ECB), for clues as to how long these unconventional policies will last.

It is not, in the words of Dr Frenkel, “a healthy situation”.

Last year’s ‘taper tantrum’ is a case in point. In June 2013 investors rushed to exit risky positions in bonds and stocks following comments from US central bank officials that they would begin to reduce their bond purchases. The episode worried many market watchers since it was viewed as a potential prelude to the turmoil that many predict will accompany the eventual removal of central bank stimulus.

“I think that there is a consensus that the early communication regarding the planned tapering was imperfect,” Dr Frenkel says of the episode. “Communication of central bank policy is one of the most important mechanisms by which monetary policy is impacting the markets. It’s the signal. And the signal must be very clear.”

In addition to these signalling sensitivities there is also the danger of an element of ‘mission creep’ that comes about as central banks find themselves having

to jump start more and more of the mechanisms that underpin the financial system.

Pottery shop syndromeFor this hazard, Frenkel has a catchy analogy: “I would call this phenomenon the ‘pottery shop syndrome’, because in pottery shops there is typically a sign that reads ‘Don’t touch. If you break it you own it’.”

With central banks taking on increasing amounts of responsibility in the financial system there is, in other words, the potential for potential for breaking a vase or two.

The growing clout of monetary policy “may be flattering to central banks but it is also a danger,” Dr Frenkel says. “The danger is that monetary policy may become overburdened; namely, monetary policy makers may end up taking responsibility for areas that go beyond the comparative advantage of central banking.”

That’s already apparent, he says, in places like the eurozone, where Draghi suddenly seems responsible for not only achieving price stability in the region, but also healing deep economic rifts within the political union. For months, investors have speculated about the potential for additional unconventional policies from the ECB as the eurozone’s economic recovery looks increasingly frail.

“The issue is not more loans from the ECB. The issue is structural measures,” says Dr Frenkel. “The role of the ECB in principle is to provide some oxygen for the transition in which governments do their part.

The G30 is extremely informal. While I wouldn’t say that we come with our jeans, there is a jeans-like frankness.

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But if the governments do not end up doing their part then you have given oxygen for somebody who did not use it well.”

Israeli experience Dr Frenkel’s views may be coloured by his own experiences as a central banker, having served as governor of the Bank of Israel from 1991 to 2000.

Arriving there from his position as economic counsellor and director of research at the International Monetary Fund, he took charge during a time of significant challenges for Israel: the collapse of the Soviet Union had led to an influx of immigrants and inflation was rising rapidly.

Dr Frenkel’s response was to embark on a series of reforms, including removing foreign exchange controls and encouraging rapid economic growth to stabilise fast-rising prices, and he is now largely credited with sparking a revival of the Israeli economy.

“It was not easy, let me tell you, because you know there are a lot of political biases towards greater expansion and larger deficits,” he says of his success at the time.

“The reason why central banks need to be independent is not because they have their own agenda (in fact that agenda has to be set by the government elected by the people), but because the use of the policy instrument must be entirely at the discretion of the central bank because that’s the only way to protect the system from itself.”

This may go some way to explaining why Dr Frenkel is now one of a three-person steering committee at the G30 charged with examining why “central bank independence is under increasing pressure” as part of the group’s latest working project.

His current colleagues at the G30 run the gamut of ex-central bank leaders, including Axel Weber, former head of Germany’s Bundesbank and Arminio Fraga, former president of the central bank of Brazil, as well as notable figures such as former US Treasury Secretary Tim Geithner and the economist Paul Krugman.

Dr Frenkel describes the group, where he now serves as chairman of the board of trustees, as the “cream of financial regulators, practitioners and policy makers plus several academics.”

Frank exchangesWhen I ask what the meetings are like; whether there is a scrum to talk inflation targeting or perhaps heated arguments over the efficacy of QE, Dr Frenkel describes an “extremely friendly and collegial atmosphere.”

“Normally when you have policymakers meet at the G7 or G8 or whatever, they come from the political echelons, so they come with their three-piece suit and script and all the rest. Here it is extremely informal. While I wouldn’t say that we come with our jeans, there is a jeans-like frankness.”

I imagine one thing stimulating much candid discussion among the group is the potential for ‘macroprudential’ policy tools, the latest buzzword in the seemingly ever-expanding toolkit for central bankers.

These tools are meant to allow central bankers to protect financial stability with targeted action that can rein in the kind of excessive behaviour that precipitated the financial crisis while allowing them to avoid a premature interest rate rise.

In July, Yellen praised macroprudential policies as a first line of defence for central bankers seeking to maintain financial stability in the face of potentially overheating markets. In Europe, Draghi has played down the danger of bubbles citing “explicit institutional attention to macroprudential tools.” Bank of England Governor Mark Carney has already deployed the tools in an attempt to deflate the housing market.

Asset price bubbles But Dr Frenkel is less than positive about the ability of macroprudential policies to pop latent asset price bubbles brought on by low rates. Arguably a monetary policy purist, he sees macroprudential tools as having little power to offset the comprehensive impact of interest rates.

“Let’s not kid ourselves,” he says bluntly. “Interest rates are the most efficient instrument of monetary policy, period. If the use of the interest rate instrument is limited due to the zero bound constraint, can you still operate with macroprudential policies? The answer is probably ‘yes’ but it will be less efficient. In order to be effective you will need to use macroprudential measures in a draconian way.”

That leaves markets facing two unsavoury possibilities; a brutal clampdown on their frothiest and most lucrative activities or asset prices that look increasingly out of sync with vulnerable economies.

“Asset market bubbles are more likely to occur under circumstances in which interest rates are kept at an excessively low level for an extended period of time,” Frenkel says diplomatically, the eyes of Greenspan peering out from a photo behind him. “In view of the current low levels of interest rates, such dangers should not be ignored.”

2015 The Federal Reserve is expected to start raising interest rates next year.

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