In the past decade, the world’s central banks – first in the emerging and then in the developed world – have embarked on a Great Expansion in their balance sheets which is unprecedented in modern times. This blog sketches the anatomy of the Great Expansion and attempts to project what will happen as the US Federal Reserve tapers its asset purchases in the next 18 months.
The latest episode in the saga has, of course, involved the Fed’s attempt to distinguish between “tapering” and “tightening”, a distinction which the markets have been reluctant to recognise . The US forward interest rate curve shows the first rate increase occurring very close to the time when the Fed is planning to stop buying assets in mid-2014. Whether it intended to do so or not, the Fed has de facto tightened US monetary policy conditions and will have to work hard to reverse this. Read more
The chancellor’s Autumn Statement exactly marks the halfway point in the current UK parliament, and sets a course for the next election which will now be hard to change. When the coalition embarked on its economic strategy in 2010, it was fully expected that there would be a bleak electoral patch in mid-term, but the Treasury believed that the strategy would be seen to be successful by 2015. In point of fact, however, the mid term blues have been worse than predicted, and GDP forecasts for the remainder of the parliament have been sharply downgraded.
Mr Osborne has reacted to these developments by amending his budgetary strategy in two respects. First, he has allowed the fiscal stabilisers to operate in full, so the effects of the GDP downgrades have been reflected in extra public borrowing in 2011/12 and 2012/13. Sensibly, he has not been overly rigid and there has been no attempt stick to his original fiscal path. As a result, there has been almost no tightening in the underlying fiscal stance this year, and the planned tightening for next year is about 1 per cent of GDP, similar to the plans in other major economies.
Second, he has extended the time period over which the fiscal austerity will take effect, so that his formal fiscal objectives will be reached in 2016/17, instead of 2015/16. The fiscal stance will tighten by about 1 per cent of GDP in each of the next 5 years. The same amount of fiscal austerity, spread over a longer period, is the consequence of these changes. Read more
As the IMF meetings close in Tokyo this weekend, it is obvious that governments are struggling to find the correct balance between controlling public debt, which now exceeds 110 per cent of GDP for the advanced economies, and boosting the rate of economic growth. The former objective requires more budgetary tightening, while the latter requires the opposite. Is there any way around this?
One radical option now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely. Read more
The minutes of the Fed’s FOMC meeting on 18th and 19th June were published on Wednesday, but the markets remain confused and divided about the central bank’s true intentions on the stance of monetary policy. Surveys of market participants show that they are almost evenly split between those who expect QE3 to come this year, and those who do not. And usually highly informed commentators have differed sharply about the hidden meaning in this set of minutes.
Robin Harding of the FT concluded that the tone was dovish, heralding the likely arrival of QE3 if the economy remains weak. Tim Duy, in his excellent Fed watch blog, says that Ben Bernanke is sceptical about the efficacy of a further increase in the balance sheet, and is looking for different options to ease. That could take a while. Jon Hilsenrath at the Wall Street Journal said that the Fed is in a state of “high alert” about the economy, but has not yet decided to pull the trigger, partly because “many Fed officials are uncomfortable with the mix of unconventional tools that they have to address the soft economy”. In particular, there are growing concerns that further purchases of treasury securities will damage the workings of the market in government debt. The Fed staff has been asked to report back on this in future meetings. Read more
The weakness of global equities and other risk assets in recent weeks has clearly been driven by the deterioration in the eurozone crisis, but that has not been the only factor at work. There has also been concerted weakness in economic activity indicators in all the major economies, while the central banks have been sitting on their hands. That is never a good combination for asset returns.
This week, however, the markets’ hopes have been rising that the major central banks are once again preparing to ease monetary conditions, if not via a formally co-ordinated announcement, then in a series of separate steps which would amount to a powerful monetary boost to the global economy. Although this policy change may take a couple of months to transpire, it does indeed seem to be on the way. The pause in monetary easing which became clear in February/March has once again proved to be only temporary. Read more
For the first time in quite a while, the Monetary Policy Committee of the Bank of England has today made a knife-edge decision which genuinely might have gone either way. The outcome, which was to leave the total of quantitative easing unchanged at £325bn, tells us something about the inflation fighting credentials of the MPC, which have been widely questioned in the financial markets. And it also tells us something about the way in which other central banks, including the Fed, might react to similar, if less strained, economic circumstances in coming months. Read more
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. Read more
The Bank of England meets on Thursday with expectations running high that the MPC will announce a further large dose of quantitative easing. Even if they pass this month, which seems possible, this is likely to be only a temporary postponement. Whenever it comes, the next move will be another bout of “plain vanilla” QE, involving the purchase of £50-75bn of government bonds, and taking the overall Bank of England holdings to over one third of the total stock of gilts in issue.
Meanwhile, the Fed is still debating whether to increase its holdings of long dated securities, and if so whether to focus once again on government debt, or to re-open its purchases of mortgages. Any further QE would be contentious on the FOMC, but there is probably still a majority in favour.
Central bankers, unlike many others, have not lost faith in the efficacy of QE. The vast majority of them not only believe that additional asset purchases can further reduce long term bond yields at a time of zero short term interest rates, but also that this can increase real GDP growth, compared with what otherwise would have occurred. Are they right? Read more
The explosion in central bank balance sheets continues. As explained in this earlier blog, the ECB, the Fed and others have become the holders of last resort for much of the private sector risk which no-one else is willing to touch. Today’s announcement of a record liquidity injection by the ECB, along with a further rise in the Fed’s balance sheet as part of the dollar swap programme, looks particularly dramatic, but it really just represents a continuation of a process which has been underway for many months now.
Whatever they may claim to the contrary, the ECB is finding that it has no choice but to use the central bank balance sheet to stabilise the euro crisis. I am not complaining about that. The alternative would have been far, far worse. But we should call a spade a spade. This is quantitative easing on a significant scale, and the lines between this form of QE, and the direct monetisation of budget deficits, which is forbidden by the spirit of the eurozone treaties, are becoming increasingly blurred. Read more