Monthly Archives: September 2010

Chris Giles

Adam Posen, an external member of the Monetary Policy Committee, has just sounded the alarm: not about a temporary double-dip recession, but about Japanese-style prolonged economic weakness, high unemployment, trade conflicts, and extremist politics.  It is strong stuff. Monetary policy needs to do more to foster a stronger recovery, he says. Now.

His argument is worth reading in full because it is directed much wider than solely to other MPC members in the UK.

The one sentence summary. Policymakers should not settle for weak growth out of misplaced fear of inflation.

In a paragraph. Mr Posen believes output is clearly below any reasonable measure of potential, so worrying about an inflation problem is absurd. We must also not underestimate the potential for the economy to grow. If we do, that will destroy workforce skills and potentially productive machinery as well as inhibiting investment, creating a self-fulfilling bad outcome. Read more

East Asian currencies are anything but stable viewed against the dollar: the Thai baht recently topped a 13-year high – and the yen and ringgit have both outpaced the baht’s rise so far this year. Viewed against each other, of course, these appreciating currencies are more stable.

New research challenges the habit of viewing all currencies against the dollar. It goes on to suggest that “considerable regional currency stability” can be achieved in east Asia if countries target the same basket of currencies as each other – even with no “explicit co-operation”.

China’s currency policy between mid-2006 and mid-2008 should be seen in this light, the paper argues; the simple view of the renminbi against the dollar does not explain the facts nearly as well. “The RMB behaved in this two-year period as if it were managed to appreciate gradually over time against its trade-weighted basket of currencies,” argue Guonan Ma and Robert N McCauley of BIS.  Read more

There are two massive fixed exchange rate blocs operating in the world economy today, and both of them face severe strains and conflicts. The eurozone is beset by problems which are typical of fixed rate blocs in the past, with the main surplus country (Germany) refusing to increase aggregate demand, thus forcing the deficit countries to reduce demand in order to stay within the currency arrangement. This, they appear willing to do, or at least to try.

Meanwhile, the China/US bloc also has a (nearly) fixed exchange rate, and once again the surplus country (China) is refusing, or is unable, to expand domestic demand enough to eliminate the trade imbalance. But, in this case, the deficit country (the US) is increasingly unwilling to accept the consequences, and is adopting policies which are designed to break up the bloc altogether. Two blocs with somewhat similar problems, but very different responses and outcomes for the deficit countries.

In making this analogy, it is of course important to accept that the institutional arrangements surrounding the world’s two major blocs could hardly be more different, with the eurozone established as a single currency area, while the Sino/US bloc is officially a linked but flexible exchange rate area. But the critical feature of both areas is that nominal exchange rate adjustments are not permitted to equilibrate trade imbalances within either of the two blocs, so a persistent pattern of large current account imbalances has emerged. Germany and China are the two economies where chronic surpluses have emerged, while the Club Med economies and the US have the corresponding chronic deficits. Read more

James Politi

Better late than never. After months of congressional wrangling, Barack Obama, US president, finally signed into law a bill designed specifically to help small businesses.

Although their importance is sometimes overstated – many small companies make their money off the health of large corporations – they are nonetheless an important source of economic output in their own right, and that energy has definitely been lagging in this economic recovery.

The Obama administration’s answer to the problem is a $30bn fund that allows banks to receive capital injections with increasingly favourable interest rates the more they can prove that they are lending money to small businesses. This should offer some relief against the lack of credit that is hampering some small companies. In addition, there are also some $12bn in tax breaks in the legislation, which will hopefully lead to more hiring.

“So this law will do two big things. It’s going to cut taxes, and it’s going to make more loans available for small business,” Mr Obama said. “It’s a great victory for America’s entrepreneurs.”

But whether or not this moves the economic needle in any way is very much open to debate. Read more

Rising inflation expectations, and ‘steeply’ increasing house prices have encouraged the Bank of Israel to raise its policy rate, continuing a programme of rate normalisation. October’s interest rate – not shown on the chart as we are still in September – will be 2 per cent.

Inflation expectations calculated from the capital market for one year ahead and those of the private forecasters remain in the area of the upper limit of the target inflation range, with the interest rate expected to rise to about 2.7 percent in a year’s time.

Low interest rates are also encouraging housing loans: Read more

Chris Giles

The IMF tends to be a bit sniffy about countries’ economic policies in its annual report on countries’ economies. That often helps finance ministries in domestic political battles to do the right thing.

But with the new government adopting Fund-friendly fiscal policy, the Bank of England insisting it is ready to act either way on monetary policy and a strengthening of financial policies on the way, the Fund has been reduced to a schoolkid’s crush in its latest assessment of the UK economy. I understand from the Treasury that the chancellor is pleased.

Here are some highlights. On the immediate economic outlook:

“This progressive strengthening of private and external demand should underpin a moderate-paced recovery, even as the public sector retrenches.”

Even though the IMF said Read more

ECB bond purchases have moderated again, down to €134m last week from €323m the week before. This is well within tolerance, as the chart shows. So while there may be renewed concerns over the eurozone periphery, the central bank’s covered bond purchases do not yet hint at structural support.

Related post: ECB bond purchases are noise (Sep 14)

Ralph Atkins

The health of eurozone banks faces a fresh test this week when they are due to roll over €225bn in loans, the largest amount at the ECB since early July, when €442bn of one-year loans matured.

The return of liquidity could put upward pressure on market interest rates, while the volumes that are converted into new loans will be an important guide to levels of financial market confidence within Europe’s monetary union. The results could help determine the pace at which the ECB pursues its “exit strategy” to unwind exceptional measures. Read more

Europe’s central banks have all but halted sales of their gold reserves, ending a run of large disposals each year for more than a decade.

The central banks of the eurozone plus Sweden and Switzerland are bound by the Central Bank Gold Agreement, which caps their collective sales. Read more

Robin Harding

Federal Reserve chairman Ben Bernanke is speaking now at his old employer, Princeton University. He has taken the opportunity to forget about current monetary policy, wonk out, and talk about “The Implications of the Financial Crisis for Economics”.

Mr Bernanke’s conclusion? There are not that many implications. Most of the economic theory was correct but regulators did not update their practices to keep up with financial innovation and when the crisis came they were slow in their response.

Most of Mr Bernanke’s speech deals with microeconomics – of bank runs, moral hazard, asset price bubbles, and market liquidity – which is a little odd given that the most valid criticisms are of macro models that did not predict the crisis, and could not predict the crisis since they do not have a financial sector. Read more

James Politi

Probably the biggest open question in US fiscal policy is whether or not Congress will extend – in part or in full – more than $3,000bn in tax cuts enacted in 2001 and 2003 by George W. Bush.

With the provisions expiring at the end of the year, pressure is mounting on lawmakers to take some action in order to prevent all Americans from experiencing tax cuts on January 1 - an outcome which Goldman Sachs economist Alec Phillips this week warned would pose a significant downside risk to the US economy.

And yet, we learned yesterday that the Democratic majority in the Senate decided to throw in the towel and push back any debate and vote on the issue until after the midterm elections, prolonging the uncertainty for several more months – at least. Why ? Read more

Inevitable, really. Though we wouldn’t have expected the staid Norwegian central bank to be the first (?) to take up legal arms.

After the US Securities and Exchange Commission exposed Citi’s super senior subprime slip — in which the bank misled investors over its subprime exposure between July and October 2007 — now come the lawsuits.

The SEC fined Citi $75m for the subprime deception. Norges Bank is suing over $835m worth of losses on Citi shares and bonds incurred between January 2007 and 2009. (For those wondering — in addition to overseeing monetary policy, Norges also looks after the international investments of Norways’ humongous sovereign wealth fund).

But the 221-page complaint goes much further than just the super senior CDO/liquidity put kerfuffle. Read more

Stephanie Flanders reminds us that it takes two to tango in her latest blog post. The story concerns proposals that might fine euro members for failing to keep public finances within certain boundaries. Over to Ms Flanders:

There would be fines in the region of 0.2% of GDP for countries who borrow too much, and also smaller financial penalties for countries that don’t try hard enough to improve their competitiveness.

I’m told that competitiveness would be measured by a “persistent current account imbalance”. But as this blog has pointed out many times, it takes two to create a current account gap: if one country has a deficit, someone else must have a surplus.

In fact, all the signs are that the new system will have the same asymmetry that we see in the global economy more generally. Countries with deficits are pressured to reform, but the countries with surpluses are under no pressure to change their policies at all.

 Read more

From ft.com:

Speculation that Japanese authorities had intervened in the foreign exchange market to weaken the yen drove the currency sharply lower against the dollar. The dollar initially jumped 1.3 per cent to Y85.38 in reaction to market talk that the Bank of Japan had re-entered the market to sell yen and buy dollars. Read more

Norway’s central bank might reduce the rate it offers banks on big deposits, in an effort to discourage cash-hoarding and incentivise interbank lending. More news is expected in 2-3 weeks.

Bloomberg reportsRead more

Minutes from Poland central bank show some MPC members favoured a rate rise at the August 24 meeting. A  motion to raise rates by 50bp was put to the vote and rejected; the refinancing rate remained at 3.5 per cent.
From the minutes:

While considering the decision on interest rates, some Council members argued that the present GDP growth, with a possibility of its acceleration and a likely reduced potential output growth, could contribute to a rise in inflationary pressure in the monetary policy transmission horizon. Those members emphasized that the current level of interest rates was adequate for a situation of strong slowdown in the growth of the Polish economy and the recession in its environment, and that given recovery gaining strength in Poland it was justified to increase the NBP interest rates. Read more

First, Germany leads the euro area to a jump in GDP in Q2. Then, just a month later, a sharp fall in Germany’s PMI leads a drop in the index for the eurozone as a whole. The Purchasing Managers’ Index is not, of course, GDP. It is a survey of 4,500-odd buyers in the eurozone on a number of measures. But historically the two are closely linked. So what’s going on?

Ralph offers some insights on ft.com. First, we may be seeing an expected cooling from the rapid expansion seen earlier in the year. Second, he writes:

Earlier this week, the Bundesbank warned that the pace of German economic growth had weakened “markedly”. But it ascribed the slowdown to weaker global prospects and said the recovery remained “intact”. Although German policymakers worry about the county’s exposure to a fall in demand for its export goods, evidence is growing that the recovery is broadening with increases in real wages and falling unemployment gradually feeding through into stronger consumer spending.

 Read more