Much of the attention at the last policy meeting at the Federal Reserve was focused on the FOMC’s indication that interest rates would stay unchanged for a “considerable time”. But a more fundamental issue concerns another key phrase in the statement, which is the FOMC’s assertion that “there remains significant under-utilisation of labour resources” in the US. We are likely to find out more about this on Friday, when the US jobs data for September will tell us whether last month’s weak release was an aberration.
If there is still a large margin of slack in the labour market, despite tumbling unemployment figures, the Fed is unlikely to tighten monetary conditions very much in the next couple of years. Slack will also keep the wages share in national income low, thus boosting the profits share further. The utilisation of labour resources in America is thus critical not only for monetary policy, but also for the outlook for US equities.
The academic discipline of labour economics, which has not really been centre stage since the wage-push inflation of the 1970s, is therefore very much back in vogue. Empirical labour economists are needed to determine whether the decline in the official unemployment rate is providing the correct read on labour market slack and, if not, how to handle the problem.
This was the subject of a very timely conference at the Peterson Institute last week, which brought together many leading labour market academics, as well as key officials from the policy establishment in Washington and the wider Fed. The debate is available on the web, and is worth watching in full.
The overall message, which almost certainly reflects what the FOMC is being told by the academic and official economics community, was more dovish than I had expected.
Despite the fact that the official unemployment rate has fallen close to the Fed’s estimates of its “natural” or equilibrium rate, few empirical labour economists seem to believe, at least with any certainty, that labour resources are near full utilisation at present. Read more
© STR/AFP/Getty Images
China’s economic rebalancing has been the main downside risk to global economic activity in 2014, and will probably remain so for the foreseeable future. The industrial production figures for August were the weakest seen since the 2008-09 recession, and they were followed by a statement from finance minister Lou Jiwei to the effect that there would be no change in economic policy “in response to one indicator”.
This echoed Premier Li Keqiang’s recent speech at the summer Davos meetings, which indicated broad satisfaction with the overall thrust of policy. “Just like an arrow shot, there will be no turning back”, he promised.
The possibility of a clash between a slowing economy and a Chinese administration that appears implacably set on a pre-determined course was not what the markets wanted to hear. Many western investors have long been predicting a hard landing for China, and do not need much persuasion to believe that it is finally at hand. But recent data do not suggest that it is happening yet. Read more
As the market awaits the Federal Reserve’s statements on Wednesday, the focus is on whether the FOMC will choose to signal a significant shift in a hawkish direction since its last meeting in July. Many investors believe that the key litmus test for this will be whether it chooses to drop two words from its July statement.
These words are “considerable time”. If that phrase disappears, then the market will need to absorb the fact that the Fed has deliberately chosen to force an upward adjustment in forward interest rate expectations, for the first time in this economic cycle. Read more
As the US labour market recovers, should investors brace themselves for an earlier rate rise? I spoke to global economy news editor Ferdinando Giugliano about whether the Fed may change course this month.
With the Scottish referendum still in the balance, this blog comments on the key macro economic issues in the campaign, hopefully with as little bias as possible .
The currency question, fiscal policy and the risk of a deposit flight from the banks have been much debated, but in the end they are all linked to the age old question of taxation, with and without representation. Is Scotland really willing to risk paying higher taxes as the price of political independence? We will know the answer on Friday morning. Read more
Next week will see the sixth anniversary of the collapse of Lehman Brothers. No single financial event in the post-war period has cast such a long shadow. Until now, the scars of the financial crash have dominated the economic landscape. The utilisation of labour and capital resources in the economy has remained far below normal, the growth rate of GDP has been unable to sustain any respectable recovery by past standards, and the overhang of debt has continued to erode household confidence.
Optimistic forecasts about the recovery have been repeatedly thwarted. But the US growth rate may finally be able to sustain a normal, healthy recovery, albeit with the level of GDP still tracking far below previous long term trends.
A genuine improvement in American economic conditions seems to have taken hold in the past 12 months. This was interrupted by the extreme weather conditions last winter, but “nowcasts” suggest that the last two quarters have seen a return to robust, above trend growth rates in the US, in sharp contrast to the depressed state of the economy in the euro area. Latest activity data show the US expansion touching 4 per cent, despite the disappointing jobs data released on Friday.
The key question is whether this apparently healthy recovery in growth rates can be maintained this time. This needs to be tackled from both the demand and supply sides of the economy. Read more
The Governing Council of the ECB has announced an important package of new measures, including cuts of around 0.1 per cent in policy rates, and an asset purchase programme of unknown size, confined to private sector assets, with no sovereign bond purchases. The immediate question that investors are asking is whether this is, at last, a programme of quantitative easing by the most reluctant of all quantitative easers, the ECB.
My instant answer is yes, this is indeed QE, and in significant scale. But its effects on expectations may be dampened by the fact that Mr Draghi was obviously so reluctant to admit as much. Read more
© Daniel Roland/AFP/Getty
Mario Draghi’s remarkable speech at Jackson Hole has raised expectations that ECB purchases of sovereign debt will be soon announced by the governing council, if not this Thursday, then perhaps by the end of the year. In all the excitement about QE, the importance of Mr Draghi’s remarks about fiscal policy have gained less attention in the markets.
Mr Draghi’s speech broke new ground for an ECB president, and this could herald a significant change in the stance of fiscal policy in the entire euro area. Unusually, fiscal policy could be as interesting for markets as monetary policy in the months ahead.
Traditionally, ECB presidents have always argued in favour of fiscal austerity, and have of course refused to countenance any form of monetisation of budget deficits. The stance on monetisation changed a few months ago, and now even the Bundesbank accepts that QE is within the terms of the treaties.
But the Germanic approach to the fiscal stance (ie the level of budget deficits, as opposed to how they are financed), is only now being seriously questioned by the ECB for the first time. Not surprisingly, this is reported to have triggered consternation in Germany, and approval in France.
Mr Draghi’s new views on fiscal policy stem from a change in his underlying analysis of the economic problem facing the euro area. This has led the ECB president to throw his weight behind a fiscal plan which is slowly emerging from the European Commission, in conjunction with France and Italy. Now that the ECB has gone public on this, the pressure on Germany to give ground has increased markedly. The debate on this subject within Germany itself is clearly becoming crucial. Read more
“Pent up wage deflation” is an unfamiliar and somewhat abstruse term dropped into the economic lexicon last week by Janet Yellen at the annual Jackson Hole conference. Originally coined by researchers at the Federal Reserve Bank of San Francisco, the term is destined to be widely discussed because it is clearly influencing the US Federal Reserve chair’s thinking. If it exists, it would explain why wage inflation seems abnormally low, given the recent rapid drop in unemployment, and that could eliminate one important reason for keeping US interest rates at zero per cent for the “considerable period” promised by the central bank.
Ms Yellen is right to be aware of the concept, and to keep it under review, but in my view the Fed is unlikely to shift in a hawkish direction solely because of it. This blog explains the theoretical and empirical reason why this is the case.
(Warning some of these arguments are quite intricate – skip to the end if you want to avoid the economic debate and just want the policy implication.) Read more
For macro investors, the end of summer is usually signalled by the Kansas City Fed’s annual conference at Jackson Hole. On occasions, former Fed chairman Ben Bernanke used this gathering to indicate major changes in monetary policy, going far beyond the minor, incremental adjustments that central bankers undertake in their regular policy meetings. Two years ago, he described high unemployment as a “grave concern” and presented the case for an open-ended increase in the Fed’s balance sheet, which came to be known as QE3.
With US quantitative easing ending in October, the focus this year was on whether Fed chairwoman Janet Yellen would provide any fireworks. She did not. But Mario Draghi did, raising expectations in the markets that the European Central Bank might be ready to follow in the footsteps of Bernanke two years ago. This may be going a bit far, but the ECB President certainly stole the show this year. After Jackson Hole 2014, the world’s two major central banks are clearly headed in very different directions. Read more