Professor Christopher Sims

Professor Christopher Sims  © Getty Images

The most far reaching speech at the Federal Reserve’s Jackson Hole meeting last week was not the opening address by chairman Janet Yellen, interesting though it was, but the contribution on the fiscal theory of the price level (FTPL) by Professor Christopher Sims of Princeton University.

The FTPL is normally wrapped in impenetrable mathematical models, and it has therefore remained obscure, both to policy makers and to investors. But the subject is now moving centre stage, as Prof Sims’ lucid explanation makes very apparent. It has important implications for the conduct of macro-economic policy, especially in Japan and the eurozone member states.

In these countries, Prof Sims is challenging the claim that further quantitative easing can achieve the 2 per cent inflation target, without explicit co-operation with the government budget. In the US, he is disputing Ms Yellen’s assertion last week that the Fed has further unconventional monetary weapons in reserve if the economy is hit by negative shocks in the future. Read more

Ever since the crash of 2008, the global financial markets have been subject to prolonged periods in which their behaviour has been dominated by a single, over-arching economic regime, often determined by the stance monetary policy. When these regimes have changed, the behaviour of the main asset classes (equities, bonds, commodities and currencies) has been drastically affected, and individual asset prices within each class have also had to fit into the overall macro pattern. For asset managers of all types, it is therefore important to understand the nature of the regime that applies at any given time.

This is not easy to do, even in retrospect. There will always be inconsistencies in asset performance which cause confusion and require interpretation. Nevertheless, it is an exercise which is worth undertaking, because it can bring a semblance of order to the apparent chaos of asset markets.

Two main regimes have been in place in the asset markets of developed economies since 2012. (The emerging markets also fit the pattern, with some slight differences.)

These regimes are, first, the period in which quantitative easing was the dominant factor, from 2012 to mid 2015; and, second, the period in which deflation risk has been the dominant factor, from mid 2015 to now.

It is possible that the markets are now exiting the period of deflation dominance, and they may even be entering a new regime of reflation dominance, though this is still far from certain. Secular stagnation is a powerful force that will be hard to shake off. But if that did happen, the pattern of asset price performance would change substantially compared to the recent past. Read more

Just when it all seemed very bleak, the global economy has shown some tentative signs of a rebound in recent weeks. The improved data significantly reduce recession risks in the near term.

Last month, in our regular report on the results of our “nowcasts” for world economic activity, we pointed to a sharp weakening in eurozone growth, leading to new lows for global growth in the recent slowdown. The US and China both seemed to be stuck in a prolonged malaise, and the world growth rate had slumped to more than one percentage point below trend.

Furthermore, momentum was negative. Economic commentators, including the IMF and the major central banks, were warning of increased downside risks to global economic projections. In fact, they are still issuing these warnings.

This month, however, the data have failed to co-operate with the pessimists.

Global activity growth has bounced back to 2.6 per cent, compared to a low point of 2.2 per cent a few weeks back. Much of this recovery has occurred in the advanced economies, with our nowcast for the United States showing a particularly marked rebound after more than 12 months of progressive slowdown.

It would be wrong to place too much importance on a single month’s data, especially when the nowcasts are heavily influenced by business and consumer surveys.

These surveys have remained mixed, but downward momentum has been partly reversed in most advanced economies, especially in the US where the regional Fed surveys for March have been identified by the nowcast models as major upside surprises. In fact, sentiment had become so pessimistic that even slightly better data have represented positive surprises relative to economists’ expectations, according to the Citigroup Surprise Indices.

These better numbers still leave the global economy growing at 0.7 per cent below trend, so spare capacity in the world system is still rising, and long term underlying inflation pressures should therefore still be dropping.

Better, but still not very good, is this month’s verdict. Full details of this month’s nowcasts can be found hereRead more

The FOMC will meet on Wednesday with the markets feeling confident that there will be no change in monetary policy. This means that the $85bn per month rate of balance sheet expansion will probably remain in place. But recently chairman Ben Bernanke has conceded, rather reluctantly, that the Fed’s exit strategy from quantitative easing will soon need to be reconsidered by the committee, and the debate could start at this month’s meeting. In any event, with economists now upgrading their forecasts for US GDP for the first time in quite a while, the markets are increasingly focused on whether the exit can be handled successfully.

The first question is whether the exit will be gradual or abrupt. The chairman’s personal preference is very well known: it should be gradual, and extremely well flagged in advance. But Mr Bernanke might not be in office after next January, and there are others on the FOMC who could have different ideas. Furthermore, economic and market circumstances could change. In 1994, GDP growth and inflation both rose markedly, and the Fed slammed on the brakes without any warning. The resulting 3 per cent rise in the Fed funds rate delivered a major shock to the financial system. Read more

IMF Managing Director Christine Lagarde discusses global economic priorities at the Brookings Institution, April 12, 2012

IMF Managing Director Christine Lagarde discusses global economic priorities at the Brookings Institution, April 12, 2012

The Spring Meetings of the IMF and the World Bank will be the focus of market attention this week. IMF Managing Director Christine Lagarde has set the ball rolling, with a speech calling for policy makers to “seize the day”. She is asking for a repeat of the “London moment” in February 2009, when G20 leaders announced a co-ordinated plan to rescue the global economy.

However, while her recommendations for action are perfectly sensible, there is an air of familiarity about them. They include a call for more financial resources for the IMF; delayed fiscal tightening in some countries, combined with longer term plans for budget consolidation;  easy monetary policy in the developed economies; continued reform of the financial system; renewed labour market reforms; and measures to promote fairness and eradicate poverty. With no atmosphere of crisis surrounding the Spring Meetings, there seems little chance of anything dramatic emerging on any of these fronts this week. Read more

No-one can deny that the weakness of the housing market remains at the heart of the economic crisis in the US. In fact, it is the American equivalent of the sovereign debt crisis in the eurozone. The overhang of housing debt is forcing US households to run large financial surpluses in order to pay down their liabilities, just as the the overhang of sovereign debt in the eurozone is forcing governments to improve their financial balances. And that is resulting in weak economic activity on both sides of the Atlantic. The question of what should be done about it is now coming to the centre of the economic debate in the US. Diagnosing the problem is relatively straightforward. Solving it is not. Read more

A couple of months ago, financial markets realised that the developed economies were slowing sharply, while the policy response from central banks and finance ministries was slow, or confused, or in some cases, like the debt ceiling debacle in Washington, directly damaging. Since then, some policy makers have woken up and smelled the coffee. There have been significant policy shifts in the US, and at the ECB. But there has been no progress whatsoever in the eurozone sovereign debt crisis. Last week, that became by far the most urgent problem facing the global economy. Read more

The recent fall in equities represents a belated recognition by the markets that the global economy has been much weaker than consensus economic forecasts indicated earlier in the year. Unlike last summer, when the same thing happened, the markets have also begun to recognise that policy makers have little ammunition left in the locker to combat the downturn.

The political will needed to ease fiscal policy, even temporarily, has evaporated on both sides of the Atlantic. And monetary policy has been hamstrung by the rise in inflation, which has clearly changed the thinking of the Fed. So where is the escape route? Read more