Monthly Archives: October 2012

The Bank of Japan’s monetary policy meeting on Tuesday is the focus of much greater global attention than normal. The Japanese economy is headed into yet another downturn, and the central bank seems likely to admit that its 1 per cent inflation target will not be achieved in fiscal 2014. The meeting will probably end with another round of increased asset purchases, lifting the BoJ’s total purchase programme from Y80trn to about Y90trn-Y95trn.

That, however, is not the real reason why the BoJ is back on the global radar screen. Yet another modest rise in asset purchases, which analysts have termed “QE9″, is unlikely to impress anybody. The real reason for market attention is that there is now enormous political pressure on the BoJ to do something much more dramatic to help the economy break out of its deflationary trap. 

Today’s UK GDP figures provide a welcome ray of light after several quarters of unremitting gloom from the official statisticians. The underlying state of the economy is, of course, not as good as shown in the headline growth rate of 1 per cent in Q3 (4 per cent annualised compared with Q2). But previous quarters were wrong in the other direction, not least because of the infuriating tendency of the Office for National Statistics to understate GDP in its initial estimates for each period.

Stripping out the effects of the Jubilee Bank Holiday and the Olympics, the underlying growth rate in Q3 is probably about 0.2-0.3 per cent (0.8-1.2 per cent annualised). Kevin Daly at Goldman Sachs produces a UK activity indicator that has been growing at an annualised rate of about 1 per cent throughout 2012. This is scarcely an acceptable rate, considering how far real GDP fell during the recession in 2008/2009, but nor is it as bad as is often suggested.

The economy has not, in reality, fallen into a double dip recession this year. And because productivity growth has been so low, this low rate of GDP growth has been associated with a sharp pick-up in private sector employment. Unsatisfactory, but far from catastrophic, would seem to me the right verdict. 

Nothing in economics is more potent than a simple idea whose time has come. Illustrating this maxim, a three-page article in the IMF’s latest World Economic Outlook promises to have a greater effect on global economic policy than all of the interminable meetings held at the annual meetings of the IMF and the World Bank in Tokyo a week ago.

That article, written by IMF chief economist Olivier Blanchard and Daniel Leigh, presented evidence that the fiscal multiplier [1] in the advanced economies is considerably larger than had been assumed when fiscal austerity plans were set in train in most economies in 2010. The implication, if they are right, is that austerity is much more damging to output in the near term than was anticipated. As a result, the planned fiscal retrenchment could be hard to sustain in the next few years, not only in the eurozone but in the US and UK as well. In fact, we are already seeing signs of this in peripheral Europe and the UK. 

As the IMF meetings close in Tokyo this weekend, it is obvious that governments are struggling to find the correct balance between controlling public debt, which now exceeds 110 per cent of GDP for the advanced economies, and boosting the rate of economic growth. The former objective requires more budgetary tightening, while the latter requires the opposite. Is there any way around this?

One radical option now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely. 

When David Marsh wrote his definitive biography of the Bundesbank in 1993, he chose the following sub title: “The Bank That Rules Europe“. Feared and revered in equal measure, the Bundesbank was the model on which the ECB was built. Imitation was not, however, the sincerest form of flattery for Germany’s central bank. The arrival of the ECB removed most of its direct authority over monetary policy, leaving it with only one out of 23 votes on the governing council of the new central bank.

Recently, the Bundesbank’s President Jens Weidmann has been in a minority of one on the question of whether to launch the ECB’s new programme of Outright Monetary Transactions, to which he is fundamentally opposed. He views the proposed purchases of government debt in the troubled eurozone economies as a thinly disguised monetary bail-out of profligate governments, something which the Bundesbank had believed from the very beginning to be outside the intention of the treaties. 

The annual meetings of the IMF and the World Bank take place in Tokyo this week, and as always they provide a good opportunity to take stock of the condition of the global economy, and of economic policy.

There is much less of a crisis atmosphere surrounding this week’s meetings than there was a year ago, largely because the actions of the ECB have succeeded in calming the eurozone storm for the time being.

However, there have been significant downgrades to growth prospects in China and India in the past year, and growth in the major developed economies has been extremely unsatisfactory. 

Professor Michael Woodford of Columbia University is an extremely renowned macro-economist, and rightly so, but only recently has he occupied a central place in market thinking. Since his paper on US monetary policy at Jackson Hole, and the favourable remarks which Ben Bernanke made about him, everyone is trying to understand what his influence on the Fed might eventually mean.

His writing can be complex and intricate, which is in the nature of the subject, but his current policy recommendation is quite clear: the Fed should adopt a target for the level of nominal GDP which would have the effect of increasing price inflation, and inflation expectations in the period ahead, and thus reduce the real rate of interest.

If the controlling majority which surrounds the chairman on the FOMC has fundamentally accepted the thinking which backs these recommendations, as many investors believe, then there has been a profound change in Fed strategy. However, I am not convinced that this is the case. Mr Bernanke has not yet crossed the inflation Rubicon.