Sovereign debt

Central bankers nowadays have the power to move the global markets by uttering nothing more than a brief, off-the-cuff remark. “Whatever it takes,” was Mario Draghi‘s version, which saved the euro last year. “In the next few meetings,” was Ben Bernanke’s equivalent last month. There will be rapt attention turned on the Fed chairman’s press conference on Wednesday to see whether he retracts that remark, which of course relates to the time when the Fed might start to slow the pace of its asset purchases.

Mr Bernanke does not carelessly throw out such remarks, so it would surely be incoherent for him to withdraw it completely this week. The Fed is unlikely to have been particularly troubled by the bout of market volatility seen lately. Much of it has come in foreign markets, which are not the Fed’s responsibility. Meanwhile, in the US itself, the reversal of the “reach for yield” is precisely what the Fed has been wanting to see for several months.

The killer phrase “in the next few meetings” is therefore likely to remain on the table after the press conference on Wednesday. However, the Fed chairman will hammer home exactly what he means by this message, since there are signs that it has been misunderstood by investors. In particular, the US Treasury market is sending some messages which should worry the Fed. 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

Predictably, the chancellor has rejected calls for a radical change in his economic strategy. Plan A has not morphed into Plan B. If anything, it has become Plan A-plus, with the underlying path for fiscal tightening left unchanged, and a little more flexibility for the Bank of England to pursue unconventional monetary stimulus.

UK real GDP is still stuck some 5 per cent below its pre-crisis level, the worst record among the major economies, apart from Italy. Some of this is certainly due to the problems which the Coalition inherited. However, about half of the shortfall in UK growth in recent years, compared to that in the US, is due to the tightening of 5 per cent of GDP in fiscal policy since 2009/10.

The dominant criticism of the government from mainstream economists is, of course, that the poor performance of UK GDP is due to a shortfall in aggregate demand, which in turn is primarily due to these fiscal measures. The Chancellor’s reply is that the UK could have faced a fiscal crisis without his budgets. The fact that public debt is now forecast to rise to 85 per cent of GDP in 2017/18 suggests that his concerns are not easy to dismiss as scare-mongering. Read more

The chairman of the Federal Reserve Ben Bernanke. Getty Images

There have been three important developments in central banking in the past week, which together indicate that their approach to inflation targeting, one of the few features of pre-2007 policy orthodoxy that has survived the financial crisis, may now be subject to radical change. (See Robin Harding on the “quiet revolution” at the central banks.) It is greatly premature to declare that inflation targeting is dead, but things are clearly on the move.

In the UK, the incoming Bank of England governor Mark Carney has suggested nothing less than the abandonment of the short-term inflation objective altogether, and has mooted the possibility of a nominal GDP level target, which is a beast with very different stripes. In Japan, the new Abe government intends to impose a higher (2 to 3 per cent) inflation target on the central bank, which can probably be hit only by pushing the yen lower.

In the US, there has been a clear shift in the Fed’s policy reaction function, or “Taylor Rule”, increasing the weight placed on unemployment and reducing the weight on inflation. The nature and importance of the Fed’s policy shift has not yet been fully understood, because it was not really spelled out by Chairman Bernanke in his press conference this week. Read more

Mario Draghi

Mario Draghi — Getty Images

In Mario Draghi’s first meeting as the new president of the ECB on Thursday, he already faces a decision which could determine the eventual fate of the euro. This is not a decision about whether to cut short term interest rates. They will be cut, decisively, before the year end. Nor is it a decision about the maintenance of non-standard measures to inject liquidity into the eurozone’s banking sector. These measures will be maintained and increased.

Instead, his historic decision will be whether to use the balance sheet of the central bank to purchase the troubled debt of countries like Italy and Spain, and thus effect a large transfer of resources between the member states of the eurozone – a transfer which the political leaders of the zone have so far been unable to undertake. It is becoming increasingly clear that, among European institutions, only the ECB has the constitutional authority and the financial muscle to undertake such a transfer. But is it appropriate territory for a central bank to enter? That is President Draghi’s dilemma. Read more

Under normal circumstances, the decision of the ECB to raise interest rates by 0.25 per cent at a time when the European economy is slowing, and inflation seems to be peaking, would have been a very big deal. However, with the peripheral debt crisis still deteriorating, the rate increase has not really been the centrepiece of market attention today.

Instead, the main focus is on the composition of the ECB’s balance sheet, where a much larger, if slower moving, story is unfolding. The ECB is gradually being drawn into the “socialisation” of peripheral country debt, in ways which are completely outside the control of the central bank, and which could yet end in crisis.

Today, the ECB decided to continue accepting Portuguese debt as collateral for repo operations, even though Portugal has been downgraded by Moody’s this week. The ECB is increasingly taking actions which they would have deemed unthinkable two years ago. But they are trapped, and will remain trapped until there is a more comprehensive solution to the peripheral debt crisis. Read more

How much government debt is too much government debt? That question is pertinent in most economies today, but is especially pertinent in the US, where Congress is debating whether to raise the government debt ceiling, and if so on what terms. Unless economists can give sensible advice on the appropriate maximum level for public debt, much of the debate on budgetary policy is based on little more than political bias or, even worse, gut feeling dressed up as expert opinion. Read more

There have been definite signs of progress this week on European sovereign debt. The ECB is pressing governments to get “ahead of the markets” and come up with a comprehensive solution to the crisis in the next few weeks. Meanwhile, there is talk that Germany may have at last decided that its own narrow national interest would be best served by agreeing to a larger and more generous package of European support for the troubled nations.

Although the optimists may be over-stating the degree to which German thinking has actually changed, something is clearly afoot. For the first time since the crisis started last May, there is a chance that the EU could surprise the markets with a coherent response to the problem. Read more