Central Banks and the IMF – The world economy as at October 14*

Monetary policy has been at the heart of recent market trends once more. The minutes from the US Federal Reserve’s meeting on September 17 and 18 as well as from the ECB meeting on September 12 reveal that central bankers’ views can be fairly diverse. In other news, the Fed announced that it would be buying T-bills to tackle liquidity risk, such as the situation witnessed after September 17 on the US money market. These various factors led to uncertainty and more divergent projections for the financial markets, with interest rates surging as a result.

In the US, the Fed decided to lower the target range for the federal funds rate by 25bps at its September 18 meeting, from a range of 2.00-2.25% to a range of 1.75-2.00%. The dot plot also points to a further likely cut in December.

However, James Bullard, President and CEO of the Federal Reserve Bank of Saint Louis, was in favor of a 50bps cut to help growth take an uptick more quickly and promote a more rapid return of inflation. At the same time, Esther George, President and CEO of the Federal Reserve Bank of Kansas City, wanted to keep interest rates steady as she believes that greater monetary accommodation is not yet necessary given the current state of the economy. Meanwhile, Eric Rosengren, President and CEO of the Federal Reserve Bank of Boston, believes that monetary policy is already sufficiently accommodative judging by the pace of the economy, and that further moves are not necessary. The various central bankers in the US do not share the same view of how the Fed should act, and this could lead to uncertainty for investors.

In the euro area, the ECB’s decisions at its September 12 meeting did not all meet with the same enthusiasm. The decision on banks’ role in financing the real economy via the TLTRO program was approved easily – it is vital to facilitate funding for the economy to ensure strong renewed growth.
The two-tier system for reserve remuneration was also agreed, and banks’ reserves will no longer be entirely subject to the negative deposit facility rate, which was cut to -0.5%. As much as six times banks’ mandatory reserves may now be exempt from the deposit facility rate, and this means a hefty transfer of financing from the Eurosystem to the banking system. The aim here is to safeguard a robust banking system to ensure that monetary policy moves feed through to the real economy. However, there were discussions as to whether these measures were compatible with an easing in the terms of the TLTRO program.
There was even more dissent on the issue of forward guidance. Interest rate and quantitative easing measures will be maintained until inflation converges to a level sufficiently close to, but below, 2% on a structural basis. Should the bank have kept this measure time-specific or should it make moves dependent on achieving the inflation target? Was this the focus for debates?

The most hotly debated issue was the resumption in the quantitative easing program. The ECB will resume its asset purchase program on November 1 at a pace of €20bn per month. This will round out reinvestment of principal payments from maturing securities in the ECB’s portfolio of around €10bn. The new-look QE program is expected to end shortly before the ECB starts raising its key interest rates, while reinvestment will continue past the date that the Governing Council starts raising key ECB interest rates.
There are questions as to the need for this move, although the ECB believes that it is necessary and that previous programs had promoted both growth and inflation. However, some critics of this policy feel that it is not necessary, while other opponents think that QE is not the right policy instrument in this situation. Interest rates surged in the euro area as a result of these various aspects, and with the Bundesbank and the Bank of France opposed to this move, investors felt that there may be some change to come. However, the governor of the Bank of France has since stated that they must now turn the page.

The important point here is that Christine Lagarde’s hands are now tied and she must follow the ECB’s decisions.

In the US, the Fed decided to inject massive liquidity into the money market. The US money market came under pressure on September 17, and the Federal Reserve Bank of New York intervened over the space of several days to inject significant cash into the system to tackle this liquidity risk, as shown by the chart on the size of the Fed’s balance sheet.
The Fed is also set to intervene by buying $60bn in T-bills between mid-October and mid-November and will then adjust this amount depending on market conditions until the second quarter of 2020. It will also continue its overnight repo operation until January 2020 to support the market’s adjustment.

The Fed does not want to call this program quantitative easing, but rather it is a way to provide the liquidity that the money market needs to avoid a shock on financial assets having any knock-on effect. This is a vital point: the central banks – and the Fed in particular – want to make sure they can address any potential financial shock very quickly and avoid any danger of it spreading. This can be seen as a transitional phase as the Fed has only set out plans until next spring, but it can also be viewed as an indication of fears that the situation could get out of hand, so every effort must be made to avoid any negative impact for the markets and the economy.

Indicators issued during week of October 7
We particularly note fairly robust industrial production figures in the euro area, apart from France where industrial output plummeted 0.9% and manufacturing output dropped 0.8% in August. Sound figures from Germany and Spain drove a 0.4% increase in production for the euro area as a whole in August.

The US labor market continues to adjust. Despite a dip in jobless numbers to hit a low of 3.5% in September, survey data show that momentum on job openings is much less robust. The labor market remains solid, but is not as buoyant as before, and this is also reflected in monthly figures on new jobs created, with both private sector and total job creations over the month at their lowest since 2010.

Looking across the globe, Chinese external trade continued to deteriorate, with exports contracting slightly and imports continuing to decline hastily. The Chinese government does not want to embark on aggressive economic stimulus: the economy is not undergoing a shock, but rather domestic demand is sluggish, as reflected by investment as well as imports. We also note the 22% collapse in exports to the US in September yoy, and this downtrend is gathering speed after a 16% drop in August. China is shifting its external trade to make it less dependent on the US, but this change could turn out to be tricky, so a more ambitious domestic policy may be needed to offset this external shock. US-China trade talks are making no progress, despite what the White House says.

Three key points to watch over the week ahead
The first is an ongoing but crucial issue – Brexit. The European summit on October 17 and 18 must address this issue and settle the final position on the matter. BoJo’s proposals for dealing with the Irish border issue are still not convincing, so if a deal is not reached at the summit the Prime Minister will have to ask for an extension, unless the 27 push the UK out of the bloc with no deal, but that seems unlikely.

The second major piece of news this week will be the US Fed’s Beige Book. These figures may clear up Esther George’s and Eric Rosengren’s doubts on the need for the Fed to cut interest rates.

The third event is the World Bank and IMF annual meetings. The IMF will give its outlook on the world economy and issue fresh projections. July’s figures indicated that we had hit the cycle peak in 2017, with a low in 2019 to be followed by a recovery in 2020, mainly on the back of a more robust economy and a rebound for emerging markets. However, doubts may emerge on this trend to an improvement.

But it’s not all doom and gloom. The good news is that Esther Duflo, Abhijit Banerjee and Michael Kremer have been awarded the Nobel prize for economics for their work on tackling poverty using ground-breaking methodology. Esther Duflo and Abhijit Banerjee published the book “Poor economics: a radical rethinking of the way to fight global poverty”, available in paperback.
So why not read this enjoyable and interesting book to find out more.

Have a good week!

This column was posted in French on Monday the 14th (See here)

“Politicians” take their revenge – My weekly column

The world of politics and politicians wants to get its own back on the central banks. Central banks have been at the very heart of steering the economy since the start of the crisis at the very least, as they have been more present and reacted more swiftly than governments, bar a few exceptions such as coordinated fiscal stimulus moves in 2009.

Yet politicians are now wading in to tackle central banks’ domination at various levels. Firstly, Democrats are championing the MMT – Modern Monetary Theory – approach, suggesting that governments are responsible for managing the economy. Then we have the politicization of the central bank, with Donald Trump’s attempts to appoint members who are not renowned first and foremost as economic experts, or Erdogan taking control of the central bank in Turkey, while in India, Modi changes governor each time the current one no longer meets his requirements.

Politicians now want the pendulum to swing back in their direction as they seek to take back control after letting central banks play a key role in steering the economy. But it may not be that straightforward.

* * *

A recap of central banks’ independence

Central banks have had a considerable grip on economic trends for the past several years. At the start of the 1980s, their role was to cut back inflation, after governments had let it spiral out of control. Paul Volcker went all out on this front, and this shift in the balance of power gained greater ground over time. Theoretical and empirical indications bore out this idea that an independent central bank was required to facilitate and optimize regulation of the economy.
When the euro area was set up, the central bank’s independence became the norm for member countries as well as several other countries.

Having two bodies to steer the economy and reform economic structures – the government and the central bank – was deemed wise. Work on coordination of economic policy has enhanced the way the two work together to make for more efficient running overall.

After the 2008 watershed, central banks’ crisis management moves increased their influence. Implementation of unconventional monetary policy in the US and the UK gave monetary authorities a major advantage, enabling governments to take on debt to address the aftershock of the financial crisis and spread out its effects over the longer term, while also covering this debt via vast purchase programs, or Quantitative Easing. Meanwhile, the development of forward guidance on expected future interest rate trends enabled central banks to steer investors’ expectations over the long term and avoid any potential unwanted rate trends.

In the euro area, the ECB became more independent when Mario Draghi took over at the helm: he made the monetary authority a true lender of last resort, gave the euro greater independence and shifted the central bank’s political balance that had been so troublesome for his predecessor to the detriment of real economic questions. Quantitative Easing and the forward guidance process also helped assert this greater independence.

* * *

Doubts over this independence

Politicians have now seen that reality is running away from them and central banks have too much clout in controlling the economy.
Donald Trump swiftly explained that excessively high interest rates hampered US growth, but Jay Powell, the Chair he had himself appointed, held up under this pressure. The President is now endeavoring to stymie the monetary policy committee by appointing members who do not have the rights skills and experience, such as Stephen Moore and more recently Herman Cain, before he retracted. The White House’s nominations have to be approved by Congress so the game is not over yet, but a potential second term for Trump in 2020 could upturn this balance due to the seats on the board coming up for nomination. This is a huge risk for the Fed’s independence over the years ahead.
Republicans in Congress very recently wanted to set a well-defined framework for the Fed’s actions along the lines of the Taylor rule. This would clearly limit the central bank’s scope to make its own interpretations of the economic situation, with the risk of triggering excessive interest rates movements that could disrupt the pace of the economy in the long term.

In the shorter term, the main doubt over central banks comes from the American Democratic party and its most left-wing potential presidential election candidates.
Bernie Saunders and Alexandria Ocasio-Cortez (AOC) in particular want to give politics precedence over economics again, with politics leading and economics merely managing. They base their approach on Modern Monetary Theory, which suggests that the size of the deficit is not very important if debt is financed in local currency: against this backdrop, the economy is steered and adjusted via changes in spending and tax and no longer by movements on interest rates primarily.

With this approach, growth and inflation would thus be better steered by the government than the central bank. A number of economists are unconvinced by this method, which is a theory in name only: it is also worrying as when governments have taken control over the economy in the past, it has been to the detriment of the central bank and often ended with phases of marked instability. This particularly calls to mind hyperinflation in Germany, although this may seem an excessive viewpoint with evenhanded elected leaders.

* * *

Long-lasting shift

What matters here is not so much the theoretical approach, but rather the potential change it could trigger in the pecking order for the economy’s different managing authorities. If the pyramid of powers were to change, the central bank’s action would then depend on the government’s moves in a radical turnaround compared to the past 40 years. There are several points worth noting.

We will need to keep a close eye on the forthcoming replacement for Draghi and other members of the board at the ECB, as we keep this balance of power in mind, particularly as these changes will take place after the European elections.

However, the central banks have a major advantage: in the past, they have systematically stuck together during crisis periods to curb risks on liquidity. This ability to react and work together outside any political framework helped reduce both the length and the extent of crises. Yet we cannot spontaneously expect any similar behavior from governments in the long term, and coordination displayed at the time of stimulus measures in 2009 only lasted a short length of time, while this was not true of the central banks.

In a recent book, Paul De Grauwe suggested that the economy is like a pendulum swing back and forward between market and state in overall management of the economy. An excessive role for the market led to imbalances, which were corrected by greater government intervention as it took back control, leading to imbalances that were only evened out by accepting a greater role for the market…

This type of pendulum swing looks unlikely, but we must be realistic: politics and politicians have taken back greater power in both China and the US, particularly in China. Meanwhile the populist movement in Europe is primarily a political movement, and it seems unlikely that this trend will end soon and for such times as the middle classes do not derive the full benefits of growth.

This post is available in pdf format My Weekly Column – 23 April 2019

What really went wrong in the 2008 financial crisis?

This article is a discussion, by Martin Wolf, of Tooze’s book on the ten years since 2008.

What, finally, are the biggest results? One comes from Tooze’s remark that “the optimistic dogma under which democracy and markets were seen as necessary complements — the mantra of the aftermath of the cold war — was dead. In its place the crisis had put a more realistic awareness of the potential tensions between the two.” This is surely right.

Yet another of these big results is that power and politics are back. US power dealt with the crisis. German power shaped the eurozone’s response. Rightwing politics reimagined a financial crisis as a fiscal one. A similar politics also shifted the emphasis from the dangers of economic insecurity and inequality to the threat from immigration. The crisis has, alas, awoken the sleeping ogres of fear and hatred.

How, if at all, will liberal democracy survive the age of Trump, Brexit, Putin and Xi? That is the biggest question raised by this transformative decade.

Continu reading amp.ft.com/content/e5ea9f2a-8528-11e8-a29d-73e3d454535d

My contribution “The World Has Changed, …”

You will find below the link to an article, “The World Has Changed, and There Is a Need for Proactive Fiscal Policies” that was published in “International Banker” in the January issue.
It analyses the economic outlook and the risk associated with imbalances in the economic policy mix

“There is an economic and political malaise in many developed countries. For most of them, their growth profile is lower than what it was before the 2007/2008 crisis. In the US, the trend growth is marginally above 2 percent, and this cycle is the weakest since World War II. And even if the unemployment rate is low, close to full employment, the perception is that there are still rooms for improvement, but in an environment without wage pressures. This is a new situation…..”
Read here

 

Uncertainty on financial markets: the role of central banks

Stock markets are trending downward very rapidly everywhere in the world. In France the CAC40 has lost 13.8% of its value since the beginning of the year. At the same time, interest rates converge to 0% or below. In Tokyo, the 10 year government bond yield is now below 0%. According to the FT yesterday, the volume of government bonds that is traded below 0% has now reached USD 6tn close to one third of the market.

How can we understand this phenomena?
Financial markets momentum depends mainly on expectations. Those latter are usually conditioned by economic prospects. But it is not sufficient at this moment. Communication from central banks is key to understand the current financial market behavior. Continue reading