The most newsy point from NY Fed president William Dudley’s speech today was his call for a change in exit strategy, urging the central bank to reinvest in its mortgage portfolio. But there was a lot more going on in the speech: Mr Dudley put a dovish spin on the Fed’s inflation target. He said bank regulation may be driving down neutral interest rates, and he put markets on notice that how they price bonds will decide how the Fed changes interest rates.
(1) Inflation is coming
Mr Dudley’s tone on inflation was different to the isn’t-it-worringly-low type of remarks that Fed officials have tended to make recently. Instead, he expects inflation to head upwards, and seemed to be testing arguments for why Fed policy should not react.
“With respect to the outlook for prices, I think that inflation will drift upwards over the next year, getting closer to the FOMC’s 2 percent objective for the personal consumption expenditure deflator . . . That said, I see little prospect of inflation climbing sharply over the next year or two. There still are considerable margins of excess capacity available in the economy—especially in the labor market—that should moderate price pressures.”
Not the ECB (Getty)
The Bundesbank has weighed in on what forward guidance means for the European Central Bank and if you want the short version it boils down to: we have not forgotten about inflation.
The ECB pledged in July to keep interest rates at or below current levels “for an extended period of time,” which, as we’ve noted before has caused some confusion as to what precisely it means.
According to Germany’s central bank, that promise does not actually mean that interest rates cannot rise or that they will necessarily remain low for a long time. As it writes in its latest monthly report:
The decisive point in correctly interpreting this statement is that it is conditional on the unchanged obligation of the Eurosystem [the ECB and the eurozone’s 17 national central banks] towards its mandate of maintaining price stability (which means, operationally, medium term inflation that is below, but close to 2 per cent)… It follows that the ECB’s governing council has not bound itself. If higher price pressures become apparent in future compared to those expected now, forward guidance in no way rules out a rise in interest rates.
Graffiti outside the ECB's future headquarters. (Getty)
Could the European Central Bank be learning a thing or two about managing the message? Ahead of Thursday’s interest rate-setting meeting, when policymakers will want to do nothing more than say “we’re holding steady”, it looks like the bank may come up with an eye-catching announcement to give everyone something to write about.
That something is the long-running and vexed question of why the bank that loves to tell you how transparent it is (well, at certain times, once you’ve cleared security and as long as you understand no quotes should be used from this conversation) keeps the minutes of its governing council meetings secret for 30 years. The practice makes it an outlier – the Federal Reserve, Bank of England and Bank of Japan all publish minutes of their monetary policy meetings within a month of the meeting that they cover. Read more
The paper at this year’s US Monetary Policy Forum – where market economists get to present to central bankers – is called “Crunch Time: Fiscal Crisis and the Role of Monetary Policy“. It shows a new wrinkle on US fiscal problems: if there is any kind of debt sustainability crisis it could make the Fed’s exit from easy monetary policy a whole lot more painful.
This is the money chart. Black is the baseline for Fed profit and loss in the coming years. Red is what happens if a fiscal crunch pushes up long-term bond yields (and hence causes losses for the Fed on its portfolio). Read more
Mark Carney, the incoming governor of the Bank of England, was grilled by MPs and his ECB counterpart Mario Draghi faced awkward questions. By Tom Burgis, Ben Fenton and Lina Saigol in London with contributions from FT correspondents. All times are GMT.
Charlie Bean’s speech on Wednesday evening was grim, even by central bankers’ standards.
Mr Bean is the Bank’s deputy governor with responsibility for monetary policy. But he doesn’t seem to think that particular policy strand can do much good. Either now, or in preventing the next bubble.
Not only did Mr Bean echo the governor’s warnings over the effectiveness (or lack thereof) of more quantitative easing in the current climate, he is also sceptical that monetary policy can curb the build-up of credit bubbles. Read more
According to the Maradona theory of monetary policy, as outlined by Sir Mervyn King, governor of the Bank of England, a central bank can let expectations that it will act – rather than actual action – do the work for it.
The theory is being tested right now by Mario Draghi, president of the European Central Bank, as his controversial “outright monetary transactions” bond-buying programme is forced to sit on the benches until the prime candidate for help, Spain, applies to the EU’s bailout fund.
As a quick reminder, the Maradona theory refers to the 1986 World Cup quarter final between England and Argentina. Diego Maradona scored a celebrated goal with a run from near the halfway line in which he beat five England players by, er, running in a straight line. Read more
Because monetary policy acts with a lag, it has to rely on forecasts.
However, as the Bank of England’s attempts at prediction have illustrated, central banks’ forecasts, and indeed those of most economists, tend to be pretty dire.
This is what Svante Öberg, first deputy governor of Sweden’s Riksbank, refers to in a speech out today as the “Catch-22 of monetary policy.” So what’s a central banker to do? Read more
Sir Mervyn King. Image by Getty.
Welcome to our live blog on Sir Mervyn King’s appearance at the Treasury select committee.
The governor has been called before the committee to field questions on the Monetary Policy Committee’s latest inflation report, which came out earlier this month.
Reporting by Claire Jones. All times are GMT.
17.16 This live blog is now closed.
17.14 Given that the hearing was supposed to be about the MPC’s inflation report, it was ironic that the governor ended up revealing more about what the FPC is likely to recommend in the financial stability report later this week. Read more
Monetary policy is no longer shrouded in mystery; the curtain has been pulled back on the great and powerful Federal Reserve to reveal Ben Bernanke.
That central bankers now bother to tell us what interest rate they are targeting owes much to a belief that more transparency affords them greater influence on markets’ and the public’s expectations, which in turn makes monetary policy more effective in affecting demand.
But how much of an impact do expectations about policy actually have on the economy? Today’s Nobel Prize has been awarded to two economists – Thomas Sargent and Christopher Sims – that have done much to answer this question. Read more
Martin Weale’s speech today shows how far the policy debate has shifted at the Bank of England. As recently as early July, this external member of the monetary policy committee was voting for higher interest rates. Now he is openly talking about restarting quantitative easing.
Mr Weale should certainly be praised for being as good as his words. In March he said he was perfectly happy to change his mind if the facts changed and he has done so. No longer voting for a rate rise does not indicate a previous error of judgment, only that circumstances have changed.
From his speech today, Mr Weale, one of the more hawkish MPC members, now clearly thinks that UK QE2 might be necessary and he believes it would work. Read more
Mervyn King has just delivered an important speech in Newcastle. As ever with the Bank of England governor, it is extremely well-written and his argument is tight. The speech is, however, infused with overwhelming self-belief and even arrogance in the face of difficult economic circumstances. Those, in a nutshell, are Mr King’s great strengths and weaknesses.
This is far from an attack on the governor. I think his “big picture” view is correct, but his unwillingness to concede mistakes undermines policy and damages the Bank’s credibility, making the Bank’s job of getting its message across rather harder than it need be.
The big picture should come from him.
“We must not lose sight of the big picture. Large – very large – shocks to relative prices are an inevitable part of the real adjustment vital to the rebalancing of the UK economy.
Current policy rate: 0.5 per cent
Consensus expectation: no change
Inflation target: 2 per cent “at all times”
CPI inflation rate: 3.3 per cent in November
Notable special measures in operation
- Quantitative easing of £200bn, under which money was created to buy government bonds between March 2009 and February 2010
- Other liquidity support to the banking sector – notably the Special Liquidity Scheme – not directly relevant for monetary policy and due to expire in early 2012
Points to watch Read more
For those following the UK’s economic recovery, there is little to cheer in today’s closely-watched indicator of the services sector. For the Bank of England, there is every reason to be pleased.
The CIPS services purchasing managers’ index fell sharply from 53 in November to 49.7 in December, a level associated with stagnation or contraction in the sector. New business was down too, as was employment. Since surveys do not intrinsically matter, the reason to worry about the CIPS survey is that it has a better record than most at foreshadowing the actual output of the private services sector – the area of the UK economy which needs to grow reasonably strongly if the recovery is going to be robust.
As the chart shows, the latest reading on the official index of services also dipped in October. Put the two together and the fourth quarter of the year starts to look rather weak.
Why is this excellent news for a Bank of England? Read more
Apologies for the terrible pun. The point is that Charlie Bean’s speech today could have been delivered in mid 2008. If fact, the Bank’s deputy governor did deliver a very similar speech in April 2008. Mostly, Mr Bean is optimistic:
“As 2010 draws to a close, the good news, then, is that the recovery, here and more widely, has remained on track, following the sharpest downturn in activity since the Great Depression. Such an outcome was by no means guaranteed twelve months ago; for that we must be grateful.”
But he is also aware growth could disappoint in 2011 as the credit crunch still bites and fiscal tightening hits hard:
“In many developed countries, the after-effects of the financial crisis still linger, in the form of banks that are still overly reliant on official support, fragile household and business confidence, and bloated public sector deficits and debt.”
The trouble is that the deupty governor is also concerned about inflation overshooting the target: Read more
A new game has been launched by the ECB – and apparently even the San Francisco Fed is tweeting about it. If you thought “monetary policy” and “game” couldn’t be sensibly strung together in a sentence, think again. The game – available in 22 languages – asks you to alter the interest rate to keep inflation stable, showing various other indicators too. There seem to be different scenarios behind the programme, as sometimes inflation stays stubbornly high, and other times it trends steadily towards deflation. (Yes, I have played it several times; and yes, only once did I achieve this gold star.)
Another game – on inflation – is available. Apparently it is equally as fun, though I can’t get it to work on firefox or internet explorer. Perhaps the games are simply oversubscribed from economists needing a little Friday fun….
Here’s Nomura on what it calls signs of ‘postmodern monetary policy’ in emerging Europe and the Middle East. It’s a very apt phrase describing the confusion in some central bank quarters. And it looks very familiar:
On balance, we see EEMEA central banks erring on the side of loose policy, even at the expense of higher inflation. Where there is concern about capital inflows, various policy tools are being used to decrease the carry appeal while not easing monetary conditions as much as rate cuts (or postponed hikes)…
Turkey‘s recent 400bp cut in the borrowing rate (and leaving the lending rate unchanged), while at the same time raising reserve requirements is one of the best examples of this creative policy in practice. Israel‘s efforts to ensure that implied forward rates remain at least 100bp below policy rates, or the Central Bank of Romania‘s operations in the basis swap market to minimise speculative capital flows are others. Meanwhile, the South African Reserve Bank appears to be maintaining an easing bias, despite real rates approaching negative territory, as it attempts to balance its concerns about the strength of the currency with stimulus being provided via looser fiscal policy. And in Hungary, the need for risk premia to secure inflation expectations against government policy changes is now leading to rate hikes, where none would have been expected otherwise…
When the FT reported that senior Bank of England staff including Monetary Policy Committee members thought Mervyn King, Bank governor, had overstepped the line separating monetary and fiscal policy, the governor was dismissive.
He rounded on my excellent colleague, Daniel Pimlott, who asked him whether he had the unanimous support of the MPC in endorsing the political decision on the speed and scale of the new government’s deficit reduction.
“And, just for the record, I’ve spoken far less on this than almost any other central bank governor around the world; less than Ben Bernanke, less than Jean-Claude Trichet, both of whom have given speeches in great length and regularly. I haven’t spoken on this except in response to direct questions at the Treasury Committee, and when asked by the Coalition. So perhaps we’ll move on to a serious question about the economy.”
As the overall level of growth in the UK continues to be robust – at 0.8 per cent in the third quarter – the detail of the figures just published will keep everyone guessing about the sustainability of that growth. Good news and bad news are evenly balanced and the economy is far from set fair or obviously a basket case. That is why the mushy middle prevails on the Monetary Policy Committee
- Market sector output. Real market sector output grew by 1 per cent in the third quarter, indicating robust demand. It has expanded 3.4 per cent in the year to the third quarter, indicating that the willingness to pay for additional goods and services has been strong since late 2009 and the private sector has been in good shape. This bodes well for the consolidation ahead. (Market sector output represents goods and services produced and sold in markets at meaningful prices. Most private sector activity and public sector stuff such as planning fees are included. Direct provision of free-at-the-point-of-use health and education services are excluded.)
- Broad based output gains. In the third quarter, services accounted for half the 0.8 per cent GDP rise, construction a quarter, and production the rest. The expansion was not dominated by one sector, even if construction gains were disproportionate to their size in the economy.
- A welcome boost from net trade. When looking at the expenditure contributions to growth, net trade (exports and imports) contributed 0.4 percentage points of the growth, indicating that the trade account is finally helping drive prosperity rather than detracting from it. Both imports and exports grew faster than GDP, but exports grew much faster.