IMF sees steady but fragile growth

April 16, 2012 10:58 am by Gavyn Davies

IMF Managing Director Christine Lagarde discusses global economic priorities at the Brookings Institution, April 12, 2012

The Spring Meetings of the IMF and the World Bank will be the focus of market attention this week. IMF Managing Director Christine Lagarde has set the ball rolling, with a speech calling for policy makers to “seize the day”. She is asking for a repeat of the “London moment” in February 2009, when G20 leaders announced a co-ordinated plan to rescue the global economy.

However, while her recommendations for action are perfectly sensible, there is an air of familiarity about them. They include a call for more financial resources for the IMF; delayed fiscal tightening in some countries, combined with longer term plans for budget consolidation; easy monetary policy in the developed economies; continued reform of the financial system; renewed labour market reforms; and measures to promote fairness and eradicate poverty. With no atmosphere of crisis surrounding the Spring Meetings, there seems little chance of anything dramatic emerging on any of these fronts this week.

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Tags: BRIC, china, Christine Lagarde, eurozone, G20, IMF Spring Meetings, us, World Bank
Posted in Macroeconomics | Permalink

Spain needs pre-emptive action

April 12, 2012 12:44 pm by Gavyn Davies

The wobble in risk assets in the past week has followed the Fed’s shift towards hawkishness, weaker US jobs data and the budget announcement in Spain. The fact that eurozone equities have once again underperformed US equities suggests that the Spanish budget was probably the dominant factor.

As the first graph shows, Spain’s sovereign bond yields and bank CDS spreads have recently widened to near their worst readings since the crisis started in 2010. What is even more worrying is the consistent upward trend which is apparent in the data. The eurozone rescue operation, mounted by the ECB and heads of government last December, reversed this deterioration only temporarily, and markets now seem to have resumed their earlier adverse trends. Everyone is asking whether this will trigger a new, and larger, eurozone crisis in 2012.

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Tags: Bank of Spain, ECB, ESM, eurozone, Fed, Goldman Sachs, IMF, Spain
Posted in Macroeconomics | Permalink

Why the Fed has taken QE3 off the agenda

April 3, 2012 9:14 pm by Gavyn Davies

The minutes of the Federal Open Market Committee meeting on March 13 have surprised the markets. The committee seems to have shifted in a markedly more hawkish direction than was reflected in the statement issued after the meeting, and the bar to quantitative easing 3 now seems to be rather high. Perhaps we should have expected this, given the fact that speeches by chairman Ben Bernanke and Bill Dudley since the meeting had given no hint of any further easing. But the breadth of the committee’s shift away from easing was certainly not expected.

It is easy to find hawkish phrases in the minutes. The US Federal Reserve staff has not only upgraded its real gross domestic product projections, and increased its inflation forecasts, but has also reduced its estimate of the output gap. Only “a couple” of FOMC members saw any case for further easing, and then only if growth falters or inflation falls below target. There was even some discussion of changing the guidance on keeping short rates “exceptionally low” up to the end of 2014, a move which would really shock markets.

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Posted in Macroeconomics, Monetary policy, US | Permalink

Spain in the austerity trap

April 1, 2012 4:29 pm by Gavyn Davies

Spanish workers demonstrate in Madrid during a national strike, 29 March 2012. Image by Getty

It was always likely that Spain would prove to be the key battleground in the eurozone crisis this year, and so it is proving. If the eurozone’s austerity strategy, based mainly on the imposition of fiscal contraction in the peripheral economies, works in Spain, then it will probably work elsewhere. But if it fails in Spain, the long term outlook for the eurozone would seem ominous.

The EFSF/ESM “firewall” announced last week was at the low end of market expectations, providing new funding for future crises of only €420bn by July 2013, and €500bn a year later. A medium sized Spanish crisis, involving both the sovereign and the banking sector, would comfortably absorb most of that, leaving nothing over for the many other potential calls on the eurozone’s bail-out funds. That is why the market was so focused on the Spanish budget announcements on Friday.

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Posted in Eurozone, Macroeconomics | Permalink

The optimal speed of fiscal adjustment

March 30, 2012 12:28 pm by Gavyn Davies

How rapidly should governments correct their fiscal deficits, which in the long run are unsustainable in the US, UK, Japan and many countries in the eurozone?

That is a question which continues to dominate the policy debate among economists. Rapid correction undoubtedly damages near term economic growth, but is intended to reduce the risk of a sovereign debt crisis coming suddenly out of the blue. Slow correction does the opposite. There is no theoretically “correct” policy on this. The result depends on how the near term loss of output should be weighed against the risk and consequences of a fiscal crisis, which is an empirical matter. (See this earlier blog: Assessing the risk of a financial crisis, which attempts to measure the risk of fiscal crisis.)

It is possible for reasonable economists to disagree about this, and for the “right” policy to be different in different countries. However, occasionally a piece of research comes along which changes the “dial” on the debate, and I believe that applies to the important Brookings Paper published last week by Brad DeLong and Larry Summers. This paper, which is well summarised here and here, essentially implies that the trade-off between near-term GDP growth and the probability of fiscal crisis can be irrelevant, because temporary fiscal expansions, at a time when interest rates are at the zero bound, are eventually self-financing.

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Tags: Brad DeLong, Brookings, Federal Reserve, Larry Summers, Paul Krugman, QE, sovereign debt
Posted in Macroeconomics | Permalink

A better era for global equities

March 25, 2012 5:14 pm by Gavyn Davies

Global equities have enjoyed a very strong start to 2012, rising by about 11 per cent year-to-date. This of course has been driven mostly by the improvements in the eurozone debt crisis and in the US labour market, which have raised hopes of stronger growth in global GDP in coming quarters. But on a longer-term view, equities remain in the doldrums. Relative to government bonds, equities in the developed economies have given negative excess returns for more than a whole decade, which is an extraordinary state of affairs in a free market economic system.

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UK silver linings

March 21, 2012 9:49 am by Gavyn Davies

In recent years, UK Budget Day has become the occasion for an outbreak of hand-wringing from the economics profession. Downward revisions to GDP forecasts, and upward revisions to budget deficit projections, have become the norm. Those who have criticised the chancellor for tightening fiscal policy far too quickly have increasingly felt vindicated. Calls for a Plan B, involving less fiscal stringency in the immediate future, have become deafening.

Today may be rather different. For the first time in quite a while, there is no good reason for the Office for Budget Responsibility to downgrade its previous views on the economy. The underlying improvement in the budget deficit (adjusted for the absorption of the Royal Mail pension fund into the government accounts) will stay much the same as the OBR expected in November. If you believed it then, there is no new reason to doubt it now. That should allow the chancellor to focus on micro-economic issues, such as the tax treatment of higher earners, which will generate enormous political heat, but which will not alter the path for the economy very much in either direction.

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Tags: Bank of England, George Osborne, UK Budget
Posted in Macroeconomics, UK | Permalink

A “healthy” rise in global bond yields

March 18, 2012 2:03 pm by Gavyn Davies

In the past week, government bond markets have finally done what some economists have been predicting for a while. Following a prolonged period of exceptionally low volatility, with US 10 year note yields becalmed at about 1.9 per cent, we have seen a fairly sharp sell-off, taking yields to around 2.3 per cent. Although this is a very minor blip in the large scheme of things, it does raise the question of whether the era of exceptionally low bond yields, or the government bond “bubble” as some analysts call it, may finally be coming to an end.

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Posted in Macroeconomics | Permalink

“You can’t solve a debt crisis with more debt”

March 16, 2012 12:50 pm by Gavyn Davies

“You cannot solve a debt crisis by creating more debt.” As Martin Wolf reminds us, this disarmingly simple statement has been of profound importance in shaping public attitudes to the economic crisis. The failure to make a compelling political argument against this proposition has been crucial in limiting the feasible scale of the fiscal response to the crisis.

Whether one looks at the US, the UK or the eurozone, an aversion to “more debt” has become a dominant political theme, as it did in the 1930s. Richard Koo, a leading student of the debt crisis in Japan, has even argued recently that it is impossible to respond adequately to a balance sheet recession in a democracy because the public dislike of “more debt” becomes so profound.

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Tags: Irving Fisher, Lehman Brothers, Martin Wolf, Richard Koo
Posted in Global economy, Macroeconomics | Permalink

Fed to pause after jobs data

March 11, 2012 3:34 pm by Gavyn Davies

The FOMC meets on Tuesday and, for the first time in several years, there is room for a genuine debate about whether the condition of the US labour market justifies the aggressively easy monetary stance which the Fed has adopted.

The February employment report showed strong growth in the number of jobs for the third successive month, taking both the main measures of employment gains into territory which is normally seen only during healthy economic expansions. However, as I commented in this piece for the FT’s A-List on Friday, it is dangerous to conclude that the labour market is now returning rapidly to normal. The Fed is likely to pause, but not to change its basic strategy.

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Posted in Macroeconomics | Permalink

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