Monthly Archives: April 2013

The new Funding for Lending Scheme (FLS) announced today in the UK is a useful and sensible development. It directly attacks the important micro problem of inadequate lending to small and medium sized enterprises (SMEs). But it is unlikely to have large scale macro-economic effects.

The FLS was introduced last July to address the increase in the funding costs which British banks were incurring as a result of spill-overs from the eurozone crisis. This had increased lending rates on UK mortgages and corporate loans at a time when the monetary policy committee was trying very hard to ease overall monetary conditions in the UK. And the FLS was the chancellor’s main response last year to the charge that he was deaf to the needs of the real economy, and inflexible in his pursuit of austerity policies.

Almost a year later, the verdict on the FLS is that it has significantly reduced banks’ funding costs, with the benefits of that being mostly passed on to mortgage and company borrowers, but that it has had relatively little effect on overall bank lending to companies, especially to small and medium sized enterprises (SMEs).

Today’s extension to the FLS greatly increases the incentive for banks to skew their lending to SMEs by offering them larger overall access to subsidised funding if they do that. Every pound of SME lending in 2013 will contribute tenfold to the banks’ eligible total of subsidised FLS lending. In 2014, it will contribute fivefold.

Furthermore, today’s announcement extends the FLS by 12 months to the start of 2015, thus re-assuring banks that their access to cheap funding for new lending will not suddenly disappear early next year. The Chancellor also hopes that the new FLS will help to influence the IMF’s response to his overall economic approach when they visit the UK shortly. Read more

This week’s IMF meetings in Washington lacked the sense of crisis which has characterised many such meetings since the crash in 2008. Although the official IMF growth forecasts were revised down slightly for 2013, mainly due to tighter fiscal policy in the US, the organisation also said that downside risks, relative to the central forecasts, had diminished since the October 2012 meetings.

These improved downside risks seem to have stemmed mainly from greater confidence in the financial system, reflecting the budget deal on the US fiscal cliff, and the actions of the ECB to reduce systemic threats to the euro. Global equity markets agree with this: they are up by 13 per cent since last autumn.

There is, however, a dangerous schism between the improvements in financial confidence and the marked lack of improvement in global GDP growth. On this latter problem, the Washington meetings were focused mainly on the weakness of the eurozone, with Christine Lagarde calling for “more investment” in Germany, greater steps towards banking union and bank recapitalisation, and ECB measures to deal with fragmentation in monetary conditions between the core and the periphery. The G20 statement refrained from setting any targets for public debt reduction, which suggests that Keynesian thinking is gaining ground in international policy circles.

The IMF and the US administration are as one on all this, but my impression is (confirmed here by Chris Giles) is that the gap between Washington and Berlin is wider than ever, especially on fiscal stimulus in Germany. There is a marked sense of frustration, but also of resignation, in Washington about the German approach. Plus ça change. Read more

The work of Carmen Reinhart and Ken Rogoff (RR) on public sector debt ratios, and their relationship with GDP growth, has been extraordinarily influential in academic and policy circles since 2010. Before this week, their statistical analysis, based on a 200-year database which they had painstakingly assembled covering dozens of countries, had appeared to establish an important stylised fact: that debt ratios above 90 per cent were associated with much lower rates of GDP growth than debt ratios under 90 per cent. The sudden drop in growth at a debt ratio similar to that reached in many developed economies acted as a wake up call to governments and encouraged the adoption of austerity programmes.

This week, a paper by Thomas Herndon, Michael Ash and Robert Pollin (HAP) argued that the RR stylised fact was based on simple statistical errors, including a spreadsheet error which RR have now acknowledged. Their critique of the original RR stylised fact promises to establish an alternative conventional wisdom, which is that high public debt ratios are never damaging for GDP growth. But the truth is more complicated than that, and far less certain. Read more

The IMF on Tuesday repeated its call for the ECB to reduce policy rates in the eurozone, and Mario Draghi came fairly close to promising action in May at his press conference after the governing council meeting on April 4. But no-one really believes that the expected 0.25 percentage point cut in the main refinancing rate will do very much to solve the eurozone’s most pressing problem, which is the lack of bank lending to small and medium sized enterprises (SMEs) in the troubled economies.

Monetary conditions in the eurozone are fragmented. Bank lending rates are, perversely, much higher in the weakest economies than they are in the core. Unless this is solved, the eurozone economy will remain in trouble.

In order to address this issue, the ECB needs to think in ways which are unconventional, and therefore unpalatable for many of the conservatives on the governing council. However, both Mario Draghi and his colleague Benoît Cœuré have recently hinted that they view measures to eliminate fragmented lending rates as essential to fulfil the mandate of the ECB. This is how they justified the introduction of the Outright Monetary Transactions (OMT) programme, which saved the euro last autumn.

They have also said that the power of the ECB in this area is limited, and have argued repeatedly that effective action will require co-operation from member governments and from the European Investment Bank (EIB). It is therefore probable that discussions are under way between the ECB and member states to decide what can be done. There are two options which could have significant beneficial effects. Read more

Inflation targeting is dead, or so we are told with increasing frequency nowadays. Invented in the 1990s and widely propagated in the 2000s, targets for consumer price inflation failed to prevent the asset price bubble prior to 2008, or the subsequent financial collapse. Many investors now believe that inflation targets have been abandoned in all but name.

There is, however, a major problem with this line of argument. It does not tally with what the major central banks say they are actually trying to do, either in public or in private. Far from disappearing, inflation targets continue to gain prominence. Furthermore, they still play an essential role in ensuring good economic performance.

As recently as January 2012, the Federal Reserve formalised a 2 per cent inflation objective, while the Bank of Japan did the same for the first time only last month. The ECB continues to face heavy criticism because it pays such close attention to keeping inflation “below but close to” 2 per cent. Only the Bank of England can be seriously accused of downgrading its inflation objective in recent years, and even that may have changed in the past couple of MPC meetings. Read more

The eurozone is reluctant to admit formally that it is changing its austerity strategy, but in fact it is searching in every corner of national budgets to alleviate the squeeze on its troubled economies, and rightly so.

Recently, member states which have missed their budget targets (and that has been most of them) have been given more time to reach their objectives, implying less fiscal tightening in the near term. It is not all plain sailing, as Portugal’s latest tribulations demonstrate, but the eurozone has recognised that it should not be piling even more short term fiscal contraction on declining economies. It is reported today that the troika will suggest that the average duration of official loans to Ireland and Portugal should be extended by seven years at a meeting of EU finance ministers on April 12-13. Read more

Global activity data have softened recently, especially in the US, which had previously been the one obviously bright spot in a generally bleak landscape. The US employment report for March was weak across the board, and the latest batch of business surveys suggests that the strong momentum which was apparent in the early part of the year has dissipated. Meanwhile, although China is expanding again, the eurozone has failed to maintain the signs of stabilisation which were visible earlier in the year. Even the German economy seems to be stalling, which could prove pivotal.

The American stockmarket not yet paid much attention to the weaker data, though global equities are actually no higher than the levels reached at the end of January. The next major leg up in equities may need to wait until it becomes clear whether the world economy is simply suffering from another of the mid year weak patches which have characterised the past 3 years, or is suffering from something more serious this time. Read more

Kuroda gives first press conference as governor of BoJThe package of quantitative easing announced today by the new regime at the Bank of Japan is one of the largest monetary injections ever announced by the central bank of a major developed economy. The only rival for that crown is the emergency easing in monetary policy which took place in most economies in late 2008. But today’s BoJ action has not been driven by any short-term emergency. It represents a deliberate change in philosophy, and a complete abandonment of everything that the Bank of Japan has said about monetary policy in the past two decades. Those who believe in quantitative easing certainly have their experiment, writ large in Tokyo.

In effect the new governor, Haruhiko Kuroda, has imported into Japan the whole of the Federal Reserve’s post-Lehman balance sheet strategy, and he will implement it in under two years, instead of the five years or more taken by the Fed. The doubling in the Japanese monetary base over a period of 21 months is in itself remarkable. Taken together with the extension of the duration of bonds purchased from less than 3 years to an average of 7 years, the injection becomes of historic proportions.

The new strategy brings, for the first time, a real prospect of breaking the deflationary psyche which has plagued Japan for so long. But it also brings risks that the strategy might work too well, with inflation expectations unhinging the bond market. Mr Kuroda is trying to pull off a difficult trick, which is “to drastically change the expectations of markets and economic entities”, and to do so in a very particular way. Read more