deflation

Ben McLannahan

“Inflation expectations appear to be rising on the whole.”

Check out the last 11 policy statements from the Bank of Japan: you’ll find the same line, an upgrade from a milder assertion about “some indicators” last July.

But according to the second round of the BoJ’s survey of companies’ expectations for price rises – the grand-sounding “inflation outlook of enterprises”, published on Wednesday – expectations are not rising. If anything, they’re falling. 

Claire Jones

January’s eurozone inflation number, out earlier on Monday, showed price pressures in the currency bloc are not quite as subdued as first feared, registering 0.8 per cent – a touch higher than Eurostat’s initial estimate of 0.7 per cent.

It’s hardly a game changer: inflation is still less than half the 2 per cent target. But the slightly better figure will reduce pressure on the European Central Bank a little after it faced renewed calls to ease policy following the release of the flash estimate.

However, the detail of this morning’s release suggest disinflationary pressures might be even worse than feared. This excellent chart from Marchel Alexandrovich of Jefferies International shows why: 

Several news outlets are reporting bullish overtones from Norway’s central bank, as it today kept rates on hold for the seventh month. The phrase they refer to is this: “the key policy rate should not be kept low for too long.”

This phrase was also used in October, however, and should not prejudice the reader against data on inflation and exchange rates that encourage a continued low rate. Norges Bank’s phrase might be to manage inflation expectations, or its definition of “too long” might simply be longer than that of the average journalist; but it would be quite odd if the central bank were to raise rates imminently. The bank itself says: “Both the consideration of bringing consumer price inflation up to target and the consideration of stabilising developments in output and employment imply a low key policy rate.”

Norway’s y-o-y inflation is 1.9 per cent, against a target of 2.5 per cent. It is projected to fall below 1 per cent before rising next year, with the outlying scenarios including deflation (see chart, right). Norges Bank is clearly worried about falling inflation. At the last monetary policy meeting in October, the Bank mentioned a fear that “financial imbalances … may trigger abrupt and sharp falls in output and inflation.” 

Robin Harding

All the papers at today’s Boston Fed conference on monetary policy have been fascinating but the last one of the day is the first one I’ve been free to concentrate on.

It was an fascinating – and extremely disturbing – paper on inflation dynamics by Jeff Fuhrer, Giovanni Olivei and Geoffrey Tootell of the Boston Fed.

To crudely, crudely summarise one of the most interesting conclusions they find that inflation is well modeled using expectations of inflation a year ahead and lagged inflation a year behind. 

Japan’s central bank has lowered its key rate from 0.1 per cent to a range of 0-0.1 per cent and will consider setting up an asset-purchase programme worth about $60bn to enhance monetary easing and achieve price stability.

The Asset Purchase Program is, at this point, a consideration rather than a promise: the Chairman has asked staff to examine the specifics and report back. For a consideration, it is quite well fleshed out, however:

The Bank will examine the new purchase of assets so that, principally, the outstanding balance of the total assets purchased will reach about 5 trillion yen after around one year from the start of the purchase, with about 3.5 trillion yen for long-term government bonds and treasury discount bills and about 1 trillion yen for CP, ABCP, and corporate bonds

 

The Federal Open Market Committee meeting next Tuesday promises to be the most interesting for about 12 months, since the outcome is far from certain.

The recent slowdown in the US economy seems to have caused some members of the committee to soften their stance on monetary policy, and the markets have begun to speculate about a possible easing in policy. If this comes, it is likely to be very slight, since I doubt that the Fed has seen enough evidence yet to convince them that the economy is slowing in a dangerous way.

However, some members of the committee seem to be getting increasingly worried that the US may be about to fall into a deflationary trap, like the one which has affected Japan in the last decade. James Bullard, the president of the St Louis Fed, released a very interesting paper last week which analyses the Japanese precedent in some detail. Although he does not consider this the most likely development in the US, he does think that it is sufficiently probable to require contingency planning, in much the same way as the government might prepare for a terrorist attack which it hopes and expects will not happen. 

As expected, the Bank of Japan has held its key rate at 0.1 per cent and did not announce any new easing measures. But the Japanese economy is now forecast to grow at 2.6 per cent in the year to March 2011, up from April’s forecast of 1.8 per cent. The new forecast fits with yesterday’s estimate of 2.4 per cent from the IMF.

Deflation continues in Japan, and the BoJ response on this issue was: 

Lucid and frightening argument from George Soros, courtesy of New York Review of Books:

By insisting on pro-cyclical policies, Germany is endangering the European Union. I realize that this is a grave accusation but I am afraid it is justified.

To be sure, Germany cannot be blamed for wanting a strong currency and a balanced budget. But it can be blamed for imposing its predilection on other countries that have different needs and preferences—like Procrustes, who forced other people to lie in his bed and stretched them or cut off their legs to make them fit. The Procrustes bed being inflicted on the eurozone is called deflation.

Unfortunately Germany does not realize what it is doing. It has no desire to impose its will on Europe; all it wants to do is to maintain its competitiveness and avoid becoming the deep pocket for the rest of Europe. But as the strongest and most creditworthy country, it is in the driver’s seat. As a result Germany objectively determines the financial and macroeconomic policies of the eurozone without being subjectively aware of it. When all the member countries try to be like Germany they are bound to send the eurozone into a deflationary spiral.

 

Might the Fed cap long-dated Treasury yields? This suggestion, made by Bernanke himself in 2002, has resurfaced in the blogosphere amid rising fears of deflation.

In recent days, the Washington Post’s Neil Irwin and the New York Times’ Paul Krugman have both asked what the Fed can usefully do if there is another slowdown. The meticulous Bill McBride, the man behind Calculated Risk blog, offers an insight into Bernanke’s ‘roadmap’. The speech might be old, but the thinking seems more relevant than ever.

Over to Bernanke:

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities.

There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination.

 

James Politi

The latest warning on the fate of the global economic recovery today came from the International Monetary Fund, which rather ominously stated that the risks of a slowdown have risen considerably in recent months.

In that context, I came across a fascinating – and worrying - note by John Makin, a visiting scholar at the American Enterprise Institute, a Washington think-tank, and former consultant to the Treasury department.

Mr Makin, who is also a partner at Caxton, the hedge fund, is firmly in the camp of economists who believe deflation is emerging as the biggest danger to the economic recovery, and he eloquently lays out his case.