Monetary policy

Fiscal policy activism is firmly back on the agenda. After several years of deliberate fiscal austerity, designed to bring down budget deficits and stabilise public debt ratios, the fiscal stance in the developed economies became broadly neutral in 2015. There are now signs that it is turning slightly expansionary, with several major governments apparently heeding the calls from Keynesian economists to boost infrastructure expenditure.

This seems an obvious path at a time when governments can finance public investment programmes at less than zero real rates of interest. Even those who believe that government programmes tend to be inefficient and wasteful would have a hard time arguing that the real returns on public transport, housing, health and education are actually negative [1].

With monetary policy apparently reaching its limits in some countries, and deflationary threats still not defeated in Japan and the Eurozone, we are beginning to see the emergence of packages of fiscal stimulus with supply side characteristics, notably in Japan and China.

Investors are asking whether this pivot towards fiscal activism is a reason to become more bullish about equities and more bearish about bonds, on the grounds that the new policy mix will be better for global GDP growth. This is directionally right, but it is important not to exaggerate the extent of the pivot. Read more

The ECB decided yesterday against “going negative” by reducing its deposit rate from zero to -0.25 per cent. The Governing Council again debated the pros and cons of such a measure, which would represent the first time that any of the major four central banks would ever have reduced a key policy rate to below zero [1]. Mr Draghi said again that the ECB was “technically ready” to take this action, and that the option remains “on the shelf”.

Many in the markets believe that this is just a bluff to prevent the euro from rising in the foreign exchange markets. There have been several unsupportive comments from leading members of the Governing Council (Asmussen, Mersch, Noyer and Nowotny) and Mr Draghi admitted that disagreements exist in the Council. Nevertheless, the President has deliberately left the option on the table, so it is important to understand the debate.

The technical aspects of negative rates have been very well covered in FT Alphaville recently, but I would like to focus on the broader policy implications. Why would a central bank want to take this action, and could it back-fire on them? Read more

Market expectations about Thursday’s ECB meeting had become quite bullish in the past couple of weeks (see this blog), and Mr Draghi went just far enough to justify those expectations by cutting the main repo rate by 0.25 per cent and the marginal lending rate by 0.5 per cent. This is a clever way of directing more help to those banks which need it most in the south.

Adding to his dovish tone, he talked about cutting deposit rates at the ECB into negative territory, as Denmark has already done (with moderate success), and he hinted that the ECB still has one further repo rate cut in the locker. At the less dovish end of the spectrum, he said that the ECB will not buy government bonds, which does not sound promising for Fed-style QE, should the eurozone economy continue to weaken. Read more