The US employment report on Friday was notable because it showed that the number of jobs in the American economy now exceeds the high point reached in January 2008 for the first time since the Great Recession. Another important signal that the economy is returning to normal, it might be claimed.
But a period of more than six years with zero growth in jobs in the American economy is anything but normal. According to the Economic Policy Institute in Washington, the US would need to create an extra 6.9 million jobs before the labour market could really be said to be back to normal, in the sense that all those who want employment would be fully satisfied.
The same point can be made about the path for real GDP in almost every developed economy since 2007. While several economies have now returned to their previous peak levels of output, very few have approached the previous long term trendlines which had been established for decades before that. For the developed economies as a whole, output remains about 12 per cent below these trendlines.
Because this level of output has never actually been attained in the real world, there is little sense of tangible loss about this, notably in the political sphere. Nevertheless, the opportunity cost could still be enormous. Read more
The European Central Bank’s decision to reduce the interest rate on deposits at the central bank to minus 0.10 per cent went as far as even the most ardent doves could reasonably have expected. Rates can probably fall no further. As Mario Draghi, the ECB president, said: “For all practical purposes, we have reached the lower bound.”
For that reason, the more technical elements of the package announced on Thursday in Frankfurt are in some ways the most significant. There was a €400bn injection of liquidity, in what the ECB called a “targeted longer-term refinancing operation” – a near copy of the Bank of England’s Funding for Lending Scheme. There was a form of quantitative easing, in which the central bank will buy securities backed by private sector loans. And there was the cessation of a “sterilisation” exercise, which had previously damped the monetary effect of the ECB’s purchases of government bonds.
Fears of a crash in the Chinese property market are widespread in the financial markets. That is nothing new. The domestic real estate sector has been growing at breakneck speed ever since private property ownership was first permitted in 1998, and on several occasions, most recently in 2012, there have been dire warnings from western investors that housing supply was far outstripping demand.
An easing in monetary policy headed off a hard landing two years ago, but this may only have delayed the inevitable. The renewed correction in the market in mid 2013, which now seems to be gathering momentum, is certainly the main downside risk in the global economy in 2014.
Following the devastating global impact of the US property crash of 2005-08, it is little wonder that investors are paranoid that China might be treading the same path. But there are many differences between the US then and China now. The US housing crash was transformed into something far more serious by excesses in the financial sector, and by adverse wealth effects on consumer spending.
Even though China has also built up severe credit excesses in its shadow banking sector, it is hard to make the macro arithmetic add up to a shock comparable in size to the 2008 US/global meltdown.
(Apologies for greater length than usual in this blog – skip to “GDP effects” for the bottom line.) Read more
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
The FOMC meeting this week is not likely to see any policy fireworks, but it will mark the departure of Governor Jeremy Stein, who returns to academic life at Harvard at the end of May. He has only been on the Board for two years, but he has made an intellectual mark in a critical area where leading members of the FOMC have been largely silent – how to set monetary policy when the need to maintain financial stability is conflicting with the near term outlook for inflation and employment.
The issue can be simply stated: should the Fed tighten policy solely because they are worried about the emergence of bubbles in asset prices?
After the financial crash of 2008, this should be a subject close to the heart of the new Chair Janet Yellen and her senior colleagues. Up to a point, it is. An enormous amount of attention has been given to the new financial architecture that has followed the crash, and Chair Yellen has already spoken specifically about the importance of too-big-to-fail, and the reform of the wholesale money markets.
Yet the vast majority of the Fed’s recent communication has been on the familiar topics of estimating slack in the labour market, and the consequences of this for inflation. In its statements and minutes, the FOMC has generally given very little attention to the difficult question of how to maintain financial stability and thus avoid the next “Minsky moment”. Read more
Before the financial crash in 2008, it was frequently claimed that the developed economies had permanently ended the cyclicality of prior eras. In fact, a name – the “Great Moderation” – was invented to describe the stable period from 1984-2008, when the variability of real GDP growth and inflation both fell markedly. Recessions did occur during these years, but they represented short and fairly shallow punctuations between extended periods of moderate expansion.
That was before the Great Recession of 2008-09, by far the deepest since the 1930s. The financial crash made the term “Great Moderation” seem hubristic, if not absurd, and for a while it was banished from the lexicon. But now it is back.
Economists like John Normand at J.P. Morgan (from whom I have stolen the title to this blog), and Dominic Wilson’s team at Goldman Sachs, have recently argued that the developed economies might have embarked on the Great Moderation, Version 2.0 (GM 2.0). Jason Furman, Chairman of President Obama’s Council of Economic Advisers, suggested something similar last week, though he also argued strongly that this was not a sufficient condition for a healthy economy to exist.
GM 2.0, if it persists, is likely to share some similarities with 1.0, but there are also major differences. These comparisons may be instructive for policy makers and investors in the period ahead. Read more
The OECD pointed out last week that the ratio of public debt/GDP will reach all time historic highs in 2014, at about 120 per cent. Taken in isolation, this could certainly viewed as a worrying fact, with bad implications for the future of real interest rates and possibly inflation. A couple of days later, however, the IMF published a fascinating chapter in its latest World Economic Outlook (WEO) on global real interest rates, showing that the global real rate has fallen from about 6 per cent in the early 1980s to about zero today.
Both of these facts are of course very well known, but placed side-by-side, they still represent a stark contrast:
They also present a conundrum for policy makers and investors. Why has the surge in public debt not resulted in a large rise in real borrowing costs for the government, and for the wider economy? And what does this tell us about the future of the risk free real rate in the global economy?
The risk free rate is the bedrock of asset valuation, and is often presented as one of the great “constants” in economic models. But in the past few decades, it has been anything but constant.