QE

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

The debate about whether the ECB should engage in open-ended purchases of eurozone sovereign debt rages on, and the financial markets continue to follow every twist and turn with rapt attention. This debate has legal, economic and political aspects, none of which have been confronted before in exactly this form. The custom and practice of central banking, and of the relationships between central banks and fiscal policy, is being rewritten under the glare of a global spotlight, and in the harshest of circumstances. Read more

The key focus of the coming week in financial markets will be the speech of Fed chairman Ben Bernanke at the Jackson Hole conference on Friday. Last year, the same speech was taken as confirmation that the Fed intended to embark on QE2, and this eventually triggered a 30 per cent rise in risk assets over the next six months. With the economy still weakening, the Fed is once again in easing mode, and some in the markets are hoping for another full dose of QE. They are likely to get something rather different. Read more

Risk assets like global equities have had a very bad day, but they are still trading fairly close to their highs for the year. This is surprising, given the continuing slowdown in the global economy, and the failure of policy makers in Europe and the US to come to terms with the serious problems facing them.

Particularly worrying is the growing evidence that the US economy is struggling even to hold unemployment constant, while fiscal and monetary policy have both become moribund for the time being. The markets still seem confident that US growth will spontaneously reignite in coming months, without requiring any help from expansionary policy. If they are wrong, there are few signs that US policy would be able to respond quickly or coherently. Read more

The ongoing discussions in Washington about the US public debt ceiling are raising some interesting ideas, some of which are highly unorthodox. One such idea is that the debt ceiling itself can simply be ignored because any attempt by Congress to restrict the ability of the United States to meet its debts appears, on the surface, to contravene section four of Amendment XIV of the Constitution.

This Amendment states that “The validity of the public debt…shall not be questioned.” I will leave this matter for debate among constitutional lawyers (see here and here), but as a simple economist I would question whether the US would retain its triple A status if the administration continued to make payments in contravention of an explicit act of Congress, which the President believed to be unconstitutional. What would happen to the “full faith and credit” of the United States if the Supreme Court subsequently ruled that the President was wrong? Read more

From the standpoint of a global macro economist, this is my nomination for the most important graph of the year. (See the end of this blog if you wish to suggest alternatives.) It explains why the world’s largest economy, the US, has defied the pessimists by mounting a decent recovery in 2010. Read more

Both the Federal Reserve and the ECB are now purchasing government debt in large scale. Yet neither of them seems at all eager to admit that they are doing anything unconventional with their monetary policy. In fact, some of the recent statements by both Ben Bernanke and Jean-Claude Trichet are not as straightforward and transparent as they might have been. Read more

Most forecasts for growth in the US economy have been revised upwards in recent weeks, and the financial markets have eliminated fears of a double dip recession, at least in the imminent future. A string of encouraging economic data have underpinned this rise in optimism.  Read more