Monthly Archives: January 2013

The decline of 0.1 per cent in US real GDP in 2012 Q4 (at a seasonally adjusted annualised rate) is a definite negative surprise for financial market sentiment, which has become very complacent about the ability of the US economy to withstand the fiscal tightening due to hit the economy.

Fortunately, the underlying picture for final domestic demand is reassuring, which is why the markets have taken these figures in their stride. Today’s figures are unlikely to signal a serious downturn.

But the US economy almost never posts a negative quarter in the middle of a robust upswing, so the figures should give us some pause for thought. Furthermore, the weakness of exports, which is more than a one quarter phenomenon, shows that the global economy had become dangerously dependent on the strength of the US consumer towards the end of last year. Read more

Mark carney takes questions in Davos. Getty Images

Mark Carney’s comments on monetary policy at Davos, though not specifically about the UK, opened a wide gap between his thinking and that of outgoing governor Sir Mervyn King). The latter expressed doubts last week about the ability of monetary policy to boost the economy further, given his concerns about the UK supply side, and his related worries about the 2 per cent inflation target.

At Davos, Mark Carney showed very little sympathy for any of this, arguing that there is plenty of scope for monetary policy to boost the developed economies further, and specifically saying that it might be appropriate to allow inflation to run above 2 per cent for a time in order to achieve this. It would be very surprising if Mr Carney were willing to make such remarks unless he believesthey apply to the UK. Read more

Mervyn King. Getty Images

Mervyn King’s speech on UK economic policy on Tuesday has received relatively little attention, perhaps because he is in his last few months in the governor’s seat at the Bank of England. However, it is extremely interesting , both in its analysis of the UK’s current predicament and in its recommendations for future policy action.

It lays out a distinctive course of action, which is different from the Plan A adopted by the government and the Bank in 2010, and also different from the Keynesian alternative that Olivier Blanchard of the IMF seems to have recommended at Davos.

The King plan, tinged with both pessimism and realism, argues for a long-term fix, rather than a short-term dash for salvation. But while the fix will take a long time to work, it does have some important implications for the banks, and the exchange rate, in the near term. Read more

The past few weeks have seen a surge of inflows into US equity mutual funds, following many years in which investors have preferred allocating money to bonds rather than stocks. The week ended January 9 saw the fourth largest weekly cash flow into equity mutual funds since 1992, and large investment companies such as BlackRock have spoken of a sea change in the opinion of small investors towards equities. Some analysts see this as the start of a great rotation from bonds into stocks, thus reversing the pattern of the last decade.

Others, however, point out that cash inflows from small investors tend to be contrarian indicators, since they are often driven by recent market behaviour, rather than by fundamental valuation, which is what actually determines market returns in the long run.

An interesting academic paper has recently appeared on this topic, written by two behavioural economists from Harvard, Robin Greenwood and Andre Shleifer. The paper, which is well summarised here in Free Exchange in The Economist, discusses the signals that can be derived from investor sentiment and flow data, and then contrasts these results with some standard predictions from the theory of finance. Given their results, some unexplained puzzles remain. Read more

Most economists accept that developed economies have been operating considerably below potential GDP since 2008, but there is much less agreement about the size of the output gap, and what should be done about it. This is obviously crucial. The larger the output gap, the greater the waste of resources (and, from an investor’s point of view, the greater the scope for future growth). Furthermore, the larger the gap, the smaller the budget deficit when economies return to potential, so the greater the scope for fiscal expansion today.

Keynesians have been focused on these issues for a while, and have generally had the better of the argument in the current recession. Recently, their thinking has been developing in some important respects. An example is Paul Krugman’s contribution to a panel discussion on the macroeconomics of recessions at the annual meeting of the American Economic Association in San Diego last week. (Brad DeLong, the panel chairman, has posted a transcript). Read more

The macroeconomic debate is now buzzing about “political dominance” over the central banks, under which elected politicians force central bankers to take actions they would not choose to take, if left to their own devices [1]. This is clearly what is happening in Japan, where the incoming Shinzo Abe government is not only imposing a new inflation target on the Bank of Japan (which is legitimate), but is changing the leadership of the central bank to ensure that the BoJ adopts policies compliant with the fiscal regime. This is not just political dominance, it is fiscal dominance, where monetary policy is subordinated to the decisions of those who set budgetary policy.

There have also been some early signs of political or fiscal dominance emerging elsewhere, notably in the use of the ECB balance sheet to finance cross-border financial support operations in the eurozone, and the “coupon raid” conducted by the UK Treasury on the Bank of England. Many investors have concluded that there is now an inevitable trend in place that will overthrow central bank independence throughout the developed world, allowing politicians to expand fiscal policy, while simultaneously inflating away the burden of public debt. Read more

Global equities rose by about 4 per cent last week as the markets breathed a massive sigh of relief about US fiscal policy. Yet merely avoiding the worst of the fiscal cliff is not enough to ensure a satisfactory outcome for the American economy. The fiscal and monetary strategy which has now emerged in the US bears a very close resemblance to the strategy which has been in place in the UK for the past three years. In the case of Britain, the combination of fiscal tightening along with aggressive quantitative easing by the central bank has so far led to economic stagnation.

At first blush, recent events in the UK therefore do not inspire much confidence that the US is now headed in the right direction. But the two economies are not identical, and there are solid grounds for expecting the US to perform better under its newly adopted economic approach than the UK has done. In particular, the US private sector seems to be in much better shape to absorb the effects of fiscal tightening than the UK private sector was in 2010. Read more