Central bank policy

In the past governments have funded their deficits – for example, they have borrowed in the bond market rather than through treasury bills. This is despite the fact that, for the past 80 years, the rate of interest on bonds has been greater than that on Treasury bills; that is, we have had an upward sloping yield curve.

I suggested in a recent blog that this was because governments correctly perceived that there were considerable economic risks in not funding, and that it was worth paying the additional cost to avoid these risks. Quantitative easing, which is a form of underfunding, must therefore have increased these risks. Defenders of QE need either to argue that these risks have not risen or that the benefits we have received from QE outweigh the rise in risks. To be consistent, those who hold that no additional risks have been incurred must now hold that governments should not have funded in the past and must now stop. But their silence is deafening, and such views are implausible, being held, I think, in the hope of dissuading discussion rather than from any conviction that they would survive much debate. Read more

While it is sometimes useful to make a distinction between treasuries and central banks, they are fundamentally both part of government. When central banks buy bonds as part of quantitative easing, governments are in practice ceasing to fund, ie, they are issuing short-term rather than long-term debt. If this is potentially harmful, we need to worry; if not, we need to ask why have governments funded in the past? Read more

Abenomics, the term given to the reform package Japanese prime minister Shinzo Abe launched to revive the country’s economy, is based on two myths. One is that the economy has performed badly and the second is that this non-existent failure has been due to deflation. Despite its lack of intellectual justification, the attempt to stop deflation has been a success as the accompanying rhetoric and monetary policy have produced yen weakness. This was an essential step towards solving Japan’s fiscal problem and, as the rhetoric has been about deflation rather than devaluation, the dramatic weakness of the currency has been achieved without international opprobrium.

Over time the devaluation should result in an improved current account. This will allow the fiscal deficit to fall while the economy moves ahead, but it is not enough on its own. The other essential is to reduce the cash flow surplus of the business sector. Having achieved success in step one, largely by accident, there is a chance that Abenomics will succeed in step two. If it does, it is again likely to be an accident. Read more

Ian McCafferty, an external member of the Bank of England’s Monetary Policy Committee, believes “Britain’s ‘productivity puzzle’ will persist as the economy recovers because much of the decline in output is structurally entrenched.” As a result, Mr McCafferty believes that the Bank of England “should not ‘hold back too long’ on interest rate rises”.

Scarcely a day passes without some reference to the UK’s “productivity puzzle” and a claim that the poor productivity is “inexplicable”. This reflects a failure to understand how and why the economy has changed. Poor productivity is so readily explicable that it should cause no surprise. It is, as I have sought to explain before, the natural result of the change in management incentives. Read more

“Janet Yellen, the Fed’s head, rather bizarrely used the prospective price/earnings ratio, one of the weakest of all measures, to justify a statement that Wall Street was not overvalued. (This was doubly strange since her husband, George Akerlof, co-wrote a book with Robert Shiller, who has championed a much better measure…” I quote from a recent Buttonwood column in The Economist.

Calling Ms Yellen’s comment “strange” seems very kind. Many people would rate the use of bad data in preference to better as irresponsible rather than strange, particularly when it carries with it the authority of the US Federal ReserveRead more

In my last blog I emphasised the importance of foreign investors for the Tokyo stock market, but suggested that their future behaviour was either unpredictable or momentum based. If the latter assumption is correct, foreigners are likely to amplify rather than lead changes in the market’s direction and to assess its prospects we therefore need to look at the other participants. Read more

When a central bank buys government bonds, the liquidity of the sellers rises. In the absence of changes in liquidity preference, this will drive the sellers to buy other assets, in particular non-government bonds and equities. Unless the supply of the alternative assets increases, the buying will push up their prices. Read more

Since its trough in the second quarter of 2009 living standards in the eurozone, measured by real gross domestic product per head, have recovered less than those of other major developed economies, due to less stimulatory fiscal and monetary policies.

Things now seem to be looking up and the eurozone has several relative advantages. It has higher household savings’ rates, lower fiscal deficits and higher unemployment compared with Japan, the UK and the US. Read more

The UK economy may stall but expectations for growth are generally being upgraded. Unemployment is falling rapidly and, as chart one shows, it is at or below its long-term average, depending on which measure is used. The rapid decline in unemployment indicates that growth is well above trend and the rate seems unlikely to be very different from the level at which wage rises will start to accelerate (ie, the Nairu – non-accelerating inflation rate of unemployment).

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Janet Yellen, the US Federal Reserve’s chairwoman, gave an important speech earlier this month which raised several interesting issues. One of them was emphasised by the FT US economics editor Robin Harding in an article headlined “Yellen warns inflation may lag recovery”. In the April 16 article, he said that “Ms Yellen said that high levels of unemployment had put less downward pressure on inflation than expected, so higher employment might not pull prices up again”.

There are two diametrically opposite interpretations of the change in the relationship between inflation and unemployment to which Ms Yellen has drawn attention. It is either a one-off aberration which will unwind, or a structural change. If the former, then inflation is likely to remain low for longer than would otherwise be likely; but, if the latter, inflation is likely to pick up more quickly. The difference is crucial as the former interpretation would reasonably allow the Fed to delay raising interest rates, while the latter calls for an even earlier rise than would otherwise be appropriate. Read more