There is much talk about how and when the central banks will exit from unconventional monetary accommodation, at least in the US and the UK. So far, it is all talk and not much action.
A few months ago, it all looked very different. The Fed’s “taper tantrums” from May 2013 onwards had demonstrated that markets could be very vulnerable to any hint of an end to monetary accommodation, and US monetary conditions had tightened as bond yields rose.
The People’s Bank of China had embarked on what seemed likely to be a prolonged squeeze of the shadow banking sector. The ECB was refusing to ease its stance, despite an apparent threat of outright deflation. The Bank of England was thought likely to act against the UK housing bubble by raising rates before the end of 2014. Only the Bank of Japan seemed likely to press ahead with unlimited quantitative easing.
The markets feared that Fed tapering would soon trigger a global monetary tightening. So what has happened since? Precisely the opposite. Global financial conditions, on the best indicators available, have actually eased again in the first half of this year, and now stand near to their easiest levels since the financial crisis began.
Whether or not this will prove to be a policy mistake (please do not shoot the messenger!), it is another reminder to investors that any genuine monetary tightening could still be a very long way off. Read more
The UK’s very British economic recovery, dominated by London housing in particular and the consumer more generally, continues to strengthen. The Bank of England argued in its latest Inflation Report last week that there was no case yet for higher interest rates, and repeated its previous guidance that rate rises, when they come, will be very gradual.
But Governor Mark Carney spelled out much more clearly than ever before that he is now concerned about the risks to financial stability posed by the housing sector, and he came very close to promising that the Financial Policy Committee will take regulatory steps to dampen the market at its meeting in June.
The UK housing market is therefore shaping up to be the first major test of the new macro prudential weapons that the central banks now have at their disposal. The need for these new arsenals is very apparent, but it is much less clear whether they will actually work. Read more
Macro prudential policy has been designed in the wake of the great financial crash to solve a dilemma which policy makers faced, and failed to resolve, in the late 1990s and the mid 2000s. In those periods, consumer price inflation was subdued, persuading the central banks to restrain the rise in policy interest rates. Yet the financial sector entered phases of excessive risk taking, and these eventually ended in the equity crash of 2000 and the implosion of subprime credit in 2008.
The Greenspan doctrine, that interest rates should be set to achieve macroeconomic objectives, while the effects of financial excesses could be mopped up later, was found to be badly mistaken. In its place, the monetary authorities have unveiled a new set of cyclical regulatory and prudential controls that can be tightened when financial excesses occur, while inflation remains below targets. There are increasing signs that some central bankers, notably in the Bank of England and the Federal Reserve, think that the time is coming to use these new weapons as an alternative to rate rises.
Is this view justified? And will the weapons work, if deployed? Read more
China was promoted to the largest economy in the world last week, at least according to the implications of a new data set released by the World Bank. The new figures, which were not warmly welcomed by the Chinese authorities, involved a downward revision to the prices of non traded goods and services in China, therefore increasing the real value of GDP measured at purchasing power parity exchange rates. In 2014, China will overtake the US on this definition.
While the absolute size of the Chinese economy is clearly of interest (see Martin Wolf’s lucid analysis here), it was inevitable that China would overtake the US on the basis of PPP measures within a few years, so the latest revelation was not exactly a shock. Furthermore, PPP-based comparisons have many drawbacks, as Michael Pettis explains here.
The new price data are, however, important in another respect. This concerns the valuation of the yuan, and has direct implications for Chinese exchange rate policy, which could be on the verge of a profound change. In fact, Beijing’s attitude towards its currency could turn out to be the most important change in global macro economic policy so far in 2014. Read more