Of Jackson Hole Inflation Targeting and Japan

Today sees the opening of the annual Jackson Hole symposium in Japan which has seen several “innovations” in monetary theory in the credit crunch era. The audience of central bankers who of course officially deny that their policies are “maxxed- out” to quote Bank of England Governor Mark Carney are always pleased to hear of new ways of loosening policy. One of these is likely to be in evidence later today as Janet Yellen will be deploying Open Mouth Operations from 3 pm UK time. But as there has been news this morning from the land of the rising sun I would like to look at something which has been in one of its regular phases of being hinted at. On the 16th of this month I pointed out that John Williams of the San Francisco Fed was heading that way.

First, the most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target.

In John’s Ivory Tower low inflation is a bad thing “uncomfortably low inflation………the risks of unacceptably low inflation”. We saw Charles Evans of the Chicago Fed pursue such arguments as he suggested the inflation target could be moved up to 4% and I gather he is now suggesting 3.5%.

Can they do it?

I raise the issue because the US has been below its inflation target for a while now. It has very low interest-rates in spite of the 0.25% nudge higher at the end of last year and the central bank has a balance sheet of over US $4 trillion. But PCE ( Personal Consumption Expenditure) inflation is 0.9% and whilst it is higher than the 0.5% of a year before it is lower than the 1.1% of January. Central bankers are “innovative” so they try to focus on what they call core PCE inflation which excludes food and energy but it too at 1.6% is below the target. A sign of the desperation is that people are now looking at them to two decimal places! 0.88% and 1.57% respectively in case you were wondering.

Actually both measures dipped below the 2% inflation target early in 2012 so it has been over 4 years since the Fed hit its target. You might think therefore that it would be better if its members concentrated on that rather than building castles in the sky. Well actually it is worse than that as in December 2012 we saw it implicitly raise the inflation target.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Up was the new down yet again as they completely misread things. Their efforts to raise consumer inflation turned out to be puny compared to the impact of a falling oil price. Of course their economic models would have assumed a rising oil price.

For those of you wondering how PCE differs from CPI inflation a major difference is that it has a lower weighting for owner-occupied housing costs and for that reason usually gives a lower reading. Central bankers love to exclude housing from inflation measures don’t they?


Somewhere In Tokyo Bank of Japan Governor Kuroda has Elvis Costello turned up to eleven.

Pump it up until you can feel it.
Pump it up when you don’t really need it.

He has introduced negative interest-rates and is chomping on Japanese Goverment Bonds at the rate of “at an annual pace of about 80 trillion yen”. In addition he is buying equities and commercial property.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

If you look at my articles on the “Tokyo Whale” you may note that the ETF program for equities cannot go on as it is simply because they will run out. He is also buying commercial paper and corporate bonds so soon it will be much easier to point out what he is not buying. So QE to the max or rather QQE to the max as after so many years of it QE got renamed to make it look fresh.

So inflation must be really flying? From Japan Statistics this morning.

The consumer price index for Japan in July 2016 was 99.6 (2015=100), down 0.2% from the previous month, and down 0.4% over the year……  The consumer price index for Ku-area of Tokyo in August 2016 (preliminary) was 99.6 (2015=100), up 0.1% from the previous month, and down 0.5% over the year.

As you can see all that monetary firepower and so little action. Especially troubling is that the situation I have been pointing our regularly for the UK,US and even the Euro area does not exist here. You see they have services inflation which in the first two cases is above target but in Japan that is a measly 0.3%. There is only one area above target to make Governor Kuroda smile and that is clothing and footwear at 2.4%.

What has spoiled the central banking party?

A major factor has been the lower oil price but also in a word currencies. Let me first give a public health warning please stand away from any Ivory Towers at this point. But Japan has found that after a certain point QE does not weaken the currency and actually  new efforts have led instead to a surge in the value of the Japanese Yen. The Ivory Towers would have been applauding as the Yen weakened to over 121 versus the US Dollar post the Bank of Japan negativity announcement but will now claim a lunch engagement when you want to discuss the current level of near 100.

The phase of US Dollar strength also took the US Fed away from its inflation target as in more recent times a stronger Euro is doing to the ECB. Some have lost of course as for example the ECB did when it’s initial QE efforts did weaken the Euro.

The other factor is that the central bankers have spoiled their own pitch. Plenty of countries have seen inflation in asset prices such as houses but of course the central bankers have led a long campaign to keep them out of inflation measures.


Mostly today I have discussed what are tactical issues concerning inflation targeting. This can be put simply in the form of why do you want a higher target when you cannot hit the one you have? Let me now move to strategy and there are two elements to this so let me start with Japan. After so many claims of an improvement in real wages from official sources and Bloomberg in particular we have in more recent times seen an improvement due to lower and indeed negative inflation. So exactly the reverse or a doppleganger of what they have promised! Remember wages are supposed to plummet in this environment and in fact they were strong in June as another Ivory Tower foundation turns to dust. Of course we need more than one month’s evidence as it could be one-off bonuses. But like the US and US lower inflation has led to higher real wages.

For the UK and US the situation has another nuance as we are more inflation prone. Once the phase of goods and commodity price disinflation ends then inflation is likely to head to and in the UK’s case beyond it. So why would you need an even higher inflation target?


What is the economic and fiscal situation in Scotland?

Yesterday brought us some new information on the economic situation in Scotland as the government there published its latest public finance data and updated us on the economic growth situation. So let us go straight to the GDP data.

In quarter 1 2016 the output of the Scottish economy was flat (0.0 per cent change), following growth of 0.3 per cent in quarter 4 2015. Equivalent UK growth was 0.4 per cent……Scottish GDP per person was also flat during the first quarter of 2016.

So an underperformance compared to the rest of the UK which in fact is something that can also be seen if we look back over the previous year.

Compared to the same period last year (i.e. quarter 1 2016 vs quarter 1 2015), the Scottish economy grew by 0.6 per cent. Equivalent UK growth was 2.0 per cent.

If we look back we see that the Scottish economy had a similar pattern to the rest of the UK in that economic growth pushed up to between 2% and 3% and in fact for a while did better. But since the beginning of 2015 economic growth has been slip-sliding away which has a cause you are probably already thinking of but please indulge me and hold your horses as there are complications.

Scotland’s economic structure

This is different to the rest of the UK as shown by the numbers below.

Scotland’s economy is broken down into four weighted industry categories. The breakdown for 2013 is services (75 per cent), production (18 per cent), construction (6 per cent), and agriculture, forestry and fishing (1 per cent).

So agriculture is a little higher but the main change compared to the UK numbers below is more production and  a smaller services sector.

The current 2013 – based weights are: services 78.8%; production 14.6%; construction 5.9%; and agriculture 0.7%.

You might be thinking that the production numbers should be even higher but the numbers we are given are on this basis.

This publication presents results for what is commonly referred to as the “onshore economy”, which means they exclude oil and gas extraction activity in the North Sea.

I have looked these up as they are in the overall UK numbers.

Within the production sub-industries, output from mining and quarrying, including oil and gas extraction, decreased by 2.3%;

However on an annual basis the picture was much brighter.

Mining and quarrying, including oil and gas extraction, increased by 5.3%,

For those wondering how this can be with the oil price where it is I have checked before and the numbers have been affected by past maintenance shut-downs.

Whilst the explicit oil and gas output numbers are removed there are still implicit effetcs from the industry as towns like Aberdeen depend to a large degree on it. Over the past year the break down of Scottish economic growth is shown below.

The growth in Scottish GDP in this period was due to the tail end of growth in the construction industry plus growth in the services industry (particularly distribution, hotels and catering), tempered by contractions in the production industry (particularly manufacturing).

I would be interested in readers thoughts and explanations of the construction boom. In terms of the numbers it seems to have been affected by the ESA 10 methodological changes which pushed it higher.

Construction output saw extremely strong growth in 2014 and 2015 and drove much of GDP growth over this period

The Fiscal Position

Yesterday saw the publication of the GERS dataset which estimates the revenue and public spending situation for Scotland. If we start with the revenue situation there is something glaring in the numbers.

Including an illustrative geographic share of North Sea, Scottish public sector revenue was estimated as £53.7 billion (7.9 per cent of UK revenue). Of this, £60 million was North Sea revenue.

As you can see the North Sea is not ignored here and the last sentence is not a misprint.

Scotland’s illustrative share of North Sea revenue fell from £1.8 billion in 2014-15 to £60 million, reflecting a decline in total UK North Sea revenue.

Ouch! This means that the individual position is as follows.

Scotland’s public sector revenue is equivalent to £10,000 per person, £400 less than the UK average, regardless of the inclusion of North Sea revenue.

Just to show how times change this is what we were told about 2011/12.

In 2011-12, oil and gas production in Scottish waters is estimated to have generated £10.6 billion in tax revenue, 94% of the UK total…….Total tax revenue (onshore and offshore) in Scotland was equivalent to £10,700 per person in 2011-12, compared to £9,000 in the UK as a whole.


The situation here is of higher public expenditure per person compared to the rest of the UK which is an example of regional policy in action.

Total expenditure for the benefit of Scotland by the Scottish Government, UK Government, and all other parts of the public sector was £68.6 billion. This is equivalent to 9.1 per cent of total UK public sector expenditure, and £12,800 per person, which is £1,200 per person greater than the UK average.

The Fiscal Deficit

The situation here is that Scotland is receiving the large fiscal stimulus that is being recommended by some for the rest of the UK although to be fair there have been very few suggesting one of the size below. Also at current oil prices it is noticeable how little difference North Sea Oil & Gas makes.

Excluding North Sea revenue, was a deficit of £14.9 billion (10.1 per cent of GDP)….Including an illustrative geographic share of North Sea revenue, was a deficit of £14.8 billion (9.5 per cent of GDP).

This compares to an overall UK position of.

For the UK, was a deficit of £75.3 billion (4.0 per cent of GDP).


If we stick to the economics we see an economy that is suffering from a fall in price of a natural resource that it produces. Whilst the GDP data excludes the oil & gas sector explicitly there are clear implicit effects and the fiscal position has been hit hard. However it has been shielded to some extent by its membership of the UK. This comes in various forms. Firstly the regional policy I mentioned earlier. Next we have the fact that it does not have its own currency as a Sottish Pound would presumably have been hit hard or at least a lot harder than the UK Pound has been post Brexit!Indeed there would have been very wide swings in the value of a Scottish Pound. Also a stand-alone fiscal deficit of that size would see the debt vigilantes looking to party even in these hard times for them. I do realise there are so many ironies here but as part of the UK Scotland can borrow much more cheaply than it would on its own. Oh and Bank of England policy seems much better suited to the Scottish economic situation assuming you believe that more monetary easing is a stimulus. Finally there is the size of the fiscal deficit itself which is a substantial stimulus.

Meanwhile as a sign of ch-ch-changes I would like you to join me in a journey in Doctor Who’s TARDIS back to March 2013 when we were told “the balance of risk being on the upside” for oil prices by the Scottish Government leading to this.

analysis published by the OECD in March 2013 suggests that rising demand in East Asia and continued tight supply could result in oil prices rising above $150 by 2020…….could result in oil and gas production in Scottish waters generating £57 billion in tax revenue between 2012-13 and 2017-18

Let me remind you of the words of the late and great Yogi Berra.

The future ain’t what it used to be.



Negative interest rates are the drama they seem

The subject of negative interest-rates is one which has been chronicled on here for some years now. I predicted that they would come to the Euro area and it is no great surprise that they reached Japan. Indeed the force of the negative rate tsunami is so great that there are flickerings of them reaching the UK as well. From Bloomberg on Monday.

Royal Bank of Scotland (RBS) announced it will charge negative rates to trading clients for collateral deposits.

A technical move for some business customers but it is a toe in the water nonetheless and reminds us that RBS promised/threatened such a thing before the Brexit referendum. It is always RBS isn’t it? No wonder the Financial Times is reporting its efforts to return to the private-sector are being harmed by “legacy” issues. That is one of the euphemisms of the year as we note its share price. Also there is food for thought in negative interest-rates being introduced by what is in effect a state-owned bank.

Adam Posen

Adam has written an opinion piece in the Financial Times saying that negative interest-rates are not a drama.  He used to be at the Bank of England until he resigned after this happened. From The Times in March 2011.

Adam Posen says he will leave the Bank’s rate-setting panel if his prediction that inflation will fall to 1.5 per cent next year is proved wrong.

It was and he did which on Wikipaedia has somehow metamorphosed into this.

(he) accurately forecast global inflation developments.

Negative interest-rates

Savers facing the prospect of negative interest-rates may find their blood boiling in response to the opening salvo.

This is too much fuss over just another policy instrument.

Perhaps they are just something in a place far away which can be ignored, although of course it was only Monday that I pointed out another referral to them by the US Federal Reserve’s Vice-Chair Stanley Fischer. Also Adam tells us this.

Negative rates will prove less universally applicable but have also proved predictable and useful in impact.

Actually that is simply untrue. For example how can you say they were “predictable” in Japan when Bank of Japan Governor Kuroda denied any such intention only 8 days before? Also you may note that each time they are introduced there are tweaks to the rules as to how they apply – invariably to protect the banking sector – which fits poorly with the “predictable” claim.

Adam continues with a critique of his own time at the Bank of England although of course he does not put it like that.

The first error is believing that the majority of financial decisions will respond significantly to any shifts in government borrowing costs.

Adam was perhaps the most enthusiastic advocate of QE – whose aim is to lower government borrowing costs – at the Bank of England when he was there,whereas now he seems to have seen the light that it did not achieve much if anything at all.

He suggests that we should note economic differences between countries and here he does have a point.

Sadly, any regard for such structural differences remains absent from the hyped concerns over negative rates.

Except as ever it is presented in a format that implies that savers in some counties are somehow at fault.

Economies such as Germany and Italy, where a large share of savers hold their assets in simple bank deposits and much of the corporate sector receives its financing from bank loans, will benefit less from negative rates. If anything they will suffer the direct costs.

So negative interest-rates would be a drama in Italy and Germany. Ooops! Because of course they are already there and it was only 10 days or so ago that Raiffeisen Gmund am Tegernsee announced plans to apply them to larger depositors in Bavaria. In fact in Adam’s world things would be much better if they were more like Americans.

By contrast, in economies, such as the US and Australia, where savers and companies are more flexibly financed, borrowers will move out of banks and into other forms of saving and financing.

Do you note how in the latter part of the sentence savers seem to have vanished? Also how will borrowers move into other forms of saving? I would imagine Adam means that savers will but there is a sweeping assumption here which is that they will do what he wants! What if they are happy where they are and do not want to take what they consider to be higher risks? Apparently savers in Germany and Italy have few other options which rather contradicts my financial career as at Deutsche Bank I was often dealing on behalf of such people.

Where savers have more options they tend to have more diversified assets, and so will be less resistant to negative rates.

Anyway there is a clear message of “up yours” to savers here.

But if central banks protect savers from the impact of the negative rate, they have no incentive to move funds and the overall impact of the policy will be minimal.

Also I am intrigued by the international equivalent of saver Joe Sixpack actually doing this.

and less subject to exit into global markets by dissatisfied savers.

Indeed there is the suggestion that it is a better policy for the US and UK.

Taking these oft-ignored factors into account, the BoE and even more so the Fed should be less hesitant. In the US and UK, households have more options and display more flexibility for their savings than in Japan or much of the eurozone.

There is an excellent response to this from Hamiltonian in the comments.

This nonsense is astounding.  My family are financially savvy, but to suggest that those with a proper job to do have the time to find the best way to exploit interest rate differentials, exchange rates, hedging costs, bond returns and all this in the context of varying inflation is way, way, way out of the real world.


There is something of a rewriting of history here as Adam tells us this about QE.

it worked pretty much as expected in reducing interest-rate spreads, encouraging riskier asset purchases and adjusting the currency.

It was a shame that he was not more open at the time about the plan to boost equity and house prices but as we note a soaring Yen and a rising Euro I wonder how “adjusting the currency” is going?


Let me put this another way which is that negative interest-rates have the features of a tax. The St.Louis Fed. put it like this.

But a negative interest rate is just a tax on the banks’ reserves. The tax has to be borne by someone:

As central banks operate primarily to help the banking sector this poses a problem but there are two potential “cures”.

The banks can pass the tax onto depositors by paying a lower interest rate on deposits or charging them fees for holding the deposits. In either case, depositors have less income to spend on goods and services.

Or like we have seen in Sweden.

The bank can pass the tax onto borrowers by charging them a higher interest rate on a loan or higher fees for processing the loan. In either case, it is more costly to finance purchases of goods and services by borrowing.

Or as it is the banking sector they could do both!

Let me leave you with the fact that the past policies suggested such as lower interest-rates and QE are not working so the cry goes up for “More,More,More”. Yet it is the same crew who suggested such policies who always want more “innovation”.

Yes Minister

I am a great fan of this series and it is accordingly with great sadness that I note the passing of Sir Anthony Jay who was the co-author. It is as fresh now as it ever was.

The economics of and problems created by corporate bond QE

One of the features of 2016 so far has been the appearance of QE or Quantitative Easing for corporate bonds with the ECB announcing a start in March and the Bank of England announcing a start earlier this month. This was a particular volte-face for the Bank of England which has had both the ability and the authority to purchase Corporate Bonds for some years now but had previously fiddled around in the market as if it was a market maker before abandoning the whole thing. Oh and at least one member of the Riksbank of Sweden is on the case according to Danske Bank Research.

Jochnick getting hot: is she suggesting a end to Govvie QE going into CB’s instead?

What is the rationale behind this?

There are two main routes where this could help the economy. These are via a price mechanism and a quantity one. The price mechanism is via lower corporate bond yields making it cheaper for companies to borrow which in theory will make investments cheaper. The quantity mechanism is that they should be able to issue more corporate bonds ( at lower yields) and that this extra borrowing will allow them to expand and help the economy. So in essence more corporate bonds at cheaper yields will in theory give an economic boost.

The next influence is more prosaic. Other central banks have noticed that the US Federal Reserve bought a lot of private-sector debt and still holds US $1.75 trillion of it and feel that they missed out. Perhaps it achieved a type of holy grail. Copying that is a little awkward as for example the ECB is on its third go at buying the Euro area equivalent ( covered bonds) and would be open to the accusation of being years behind even a johnny come lately. So we have corporate bond purchases which are badged as helping the private sector.

The ECB slaps itself on the back

The ECB has reviewed its own program and declared it to be a success on the two economic grounds I pointed out. First yields.

over the identified period from 10 to 24 March, 11 basis points of the total decline of 16 basis points in the spreads of euro area investment-grade corporate bonds was related to the monetary policy measures announced in March, more specifically the launch of the CSPP.

Then issuance volumes.

While issuance was subdued at the beginning of the year amid elevated financial market uncertainty, it rebounded significantly after the CSPP announcement. Preliminary data  suggest that issuance in the second quarter of 2016 was well above the average seen in previous years.

As of the end of last week the ECB had purchased some 17.8 billion Euros of corporate bonds which compares to a total program size of 1207 billion Euros.


What economic effects does lower corporate bond yields have?

The first comes as the theory that lower corporate bond yields leads to more investment collides with reality. On the 11th of this month I pointed out that the US Federal Reserve has its doubts.

Yet, a large body of empirical research offer mixed evidence, at best, for a substantial interest-rate effect on investment………Among the more than 500 responses to the special questions, we find that most firms claim to be quite insensitive to decreases in interest rates, and only mildly more responsive to interest rate increases.

At this point a few Ivory Towers will be resembling the Dark Tower of Barad-dûr as the Ring of Power goes into Mount Doom. Also if we stay with the issue of lower yields then Euro area taxpayers may be wondering why they are giving subsidies to big businesses in this way?

Yields of the purchased bonds have ranged from around -0.3% to above 3%, with just above 20% of the purchases being made at negative yields above the ECB’s deposit facility rate of -0.4%.

The incentive to make good investments fades if the money to fund it is in effect free or even more so if you are paid to borrow. On this road more debt could lead to a more sclerotic economy with increasing ossification.

What about “phantom securities”?

This is an issue faced by a previous Bank of England program (Special Liquidity Scheme) where is suddenly discovered that some of what it was buying was not what it thought it was. Awkward! Imagine going back to taxpayers and having to explain that you had been made a fool of. I believe that this was the reason the SLS was wound up early. Can history repeat itself? From the Wall Street Journal.

The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy.

Apparently there have been two private placements but like when it was giving private briefings to hedge funds the ECB appears not to have a grip on moral hazard.

“Typically there won’t be a prospectus, there won’t be any transparency, there won’t be a press release. It’s all done discreetly,”

What could go wrong?

I wish to be clear that the ECB is unworried by this and has implicitly asked for it to happen so that it can buy more bonds. The catch is that as described in both Goodhart’s Law and the Lucas Critique changing things like this can have bad consequences and destroy the intended economic effect.

There is an example of the Turning Japanese theme here. Back in one of the earlier versions of QE the Bank of Japan decided to offer cheap loans to smaller companies. The money did not reach them but it did reach the subsidiaries of Nissan, Toyota, Sony et al which suddenly sprang up. But these were pure economic and financial transactions divorced from the real economy as those companies were busy making the Bank of Japan look good not looking for investment finance.

Big Business

In essence this is yet another central banking program which helps larger businesses and in particular ones large enough to issue corporate bonds. Smaller and medium-sized businesses may reasonably feel that they have been left out again. If you think about it there will be an effect to ossify the financial system and the economy as larger companies which do not do well may simply issue corporate bonds and carry on regardless. As the Cranberries put it.

In your head
In your head
Zombie zombie zombie
What’s in your head
In your head.
Zombie, zombie, zombie

Bank of England problems

The FT published some thoughts from HSBC on the 4th of this month which pointed out this problem.

For the 29 per cent of finance that UK companies obtain from the bond market, more is issued in dollars than in euros, and more in euros than in sterling. Should the Bank choose corporate bond QE, it is not obvious that sterling corporate bonds would be the most effective choice.

So as we stand corporate bond issuance in sterling is a relatively minor deal as shown below.

There are £285bn sterling investment-grade bonds compared with £1.3tn denominated in euros and £4tn denominated in dollars, according to Dealogic.

That could of course grow although that ignores the issue of the fact that UK companies are often international and may choose to issue bonds in Dollars and Euros to match their risks and use bank lending for sterling risks. Ooops! Oh and are you thinking what I am thinking? Well it would appear that the ECB is.

Foreign companies with headquarters located outside
the euro area have not thus far increased their bond issuance in euro.

I wonder who they mean? But UK companies borrowing in Euros and being subsidised to do so by the ECB seems on the face of it to be a bigger opportunity than going to the Bank of England. (Update 9pm The comment from Noo2 below points out that this is in fact would be more difficult than I have said). Now the exchange rate is much lower even that seems to favour Euro borrowing. Perhaps the clearest sign of a sustained turn for the UK Pound will be UK corporates issuing Euro corporate bonds. Quite a potential can of worms……


So on the face of it central bankers will be able to point to lower bond yields and more issuance in response to corporate bond QE. However the latter is not going as well as claimed according to the FT.

While the ECB’s own corporate QE initially lured companies to the bond market — €50bn was sold in March, the month after the policy was announced, supply has since waned.

Also if the problem is demand in the economy as opposed to demand for finance then encouraging businesses to follow the “debt is good” mantra is yet another spider’s web for us to be caught in. Yet another boom for the financial economy that fails to reach the real economy.

I have left pension funds to last. They will be hurt by this as yields go lower again and ironically may buy longer-dated bonds if they are issued. So Bank of England QE will have had the effect of switching them from state backed UK Gilts to private-sector corporate bonds. What could go wrong?

Where is the sledgehammer for the real economy? On this road it is Hall and Oates singing to central bankers.

You’re out of touch









What will the US Federal Reserve do next?

One of the regular themes of this blog has been uncertainty about the state of the US economy post credit crunch. We have many metrics which record an improvement and yet this recovery somehow seems to be not quite like ones in the past. This is perhaps best highlighted by the data from the labor ( as they spell it) market. If we look at the headline then the situation if we use old style thinking looks rather good.

Total nonfarm payroll employment rose by 255,000 in July, and the unemployment rate was
unchanged at 4.9 percent, the U.S. Bureau of Labor Statistics reported today.

So as we approach concepts of the natural rate of unemployment and what some considered to be full employment we see that the US economy is still creating jobs. However Ivory Tower economic models would have forecast a lot more than this.

Over the year, average hourly earnings have risen by 2.6 percent.

In yet another twist they would not be predicting that real wages would be rising nor that consumer inflation would see a dip.

The all items index rose 0.8 percent for the 12 months ending July, a smaller increase than the 1.0 percent rise for the 12 months ending June.

But perhaps the biggest challenge for those in their Ivory Towers has been this.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 59.7 percent, changed little in July.

The labor force participation rate was more like 66% to 67% before the credit crunch  and this matters as falls in it flatter the unemployment numbers.In round number terms we would expect the US labor force to be around 168 million rather than the current 159 million for the level of population. There are demographic issues like an increased number of retirements as the baby boomer generation age but it is also likely that some have become what is called “discouraged”.

Open Mouth Operations

We have seen plenty of these from the US Federal Reserve in 2016 and the opening salvo came from John Williams of the San Francisco Fed on January 4th. From Reuters.

For 2016, “I think something in that three to five rate hike range makes sense at least at this time,” Williams said in an interview on CNBC.

Since then he has suggested 2-3 and 2 and as I wrote on the 16th of this month now seems to be more of fan of higher inflation targets than higher interest-rates. So a bad 2016 for his credibility, especially as we note the number of interest-rate increase so far which is 0 and the approaching US election.

Yesterday the baton was picked up by Vice-Chair Stanley Fischer.

So we are close to our targets. Not only that, the behavior of employment has been remarkably resilient.

Let us look at the thinking behind it and as ever it focuses on the labor market.

Employment has increased impressively over the past six years since its low point in early 2010, and the unemployment rate has hovered near 5 percent since August of last year, close to most estimates of the full-employment rate of unemployment.

You may note that Stan still seems to think that concepts such as full employment are at play although even he cannot avoid mentioning this.

depending on what happens to labor force participation among other things.

The “missing” 9 million only get a sideways mention.

reflecting demographic factors such as the aging of the baby-boom generation

Actually in Stan’s world all the old Ivory Tower concepts seems to be at play.

the unemployment rate is currently close to most estimates of the natural rate

Indeed he follows John Williams by still apparently believing there is a natural rate of interest as well.

The decline in estimates of r*–the neutral interest rate that neither boosts nor slows the economy–which is related to the fear that we are facing a prolonged period of secular stagnation.

In a rather extraordinary addition footnote 10 adds this to our sum of knowledge.

For the record, I note (a) that looking ahead, I expect GDP growth to pick up in coming quarters, as investment recovers from a surprisingly weak patch and the drag from past dollar appreciation diminishes, and (b) that I am an optimist.

It is hard not to wonder if like the US Federal Reserve back then Stan was an optimist heading into the 2008 recession? But if we look at part a) then it looks for now as if he is getting some support from the data.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2016 is 3.6 percent on August 16, up from 3.5 percent on August 12. ( Atlanta Fed )

Accordingly Stan may think job done in terms of Open Mouth Operations as he reads this in the Financial Times.

The Federal Reserve is close to meeting both its targets for the US economy, one of its leading policymakers said, as he delivered an upbeat verdict on the post-crisis recovery.


Even a cursory look at the rhetoric on inflation provided by our Stan poses problems.

Although total PCE inflation was less than 1 percent over the 12 months ending in June,

Like Adam Posen used to do when he was at the Bank of England Stan has to pick and chose amongst sub-indices to claim we are close to target. Rather oddly he does not seem to simply point out that he thinks inflation will pick-up going forwards. After all he is supposed to be looking 18/24 months forwards.


There is a problem here for Stan as his employment cheerleading meets the output or GDP (Gross Domestic Product) numbers.

Output growth has been much less impressive. Over the four quarters ending this spring, real GDP is now estimated to have increased only 1-1/4 percent.

So we are left noting this.

Output per hour increased only 1-1/4 percent per year on average from 2006 to 2015, compared with its long-run average of 2-1/2 percent from 1949 to 2005.

Indeed he goes further.

A 1-1/4 percentage point slowdown in productivity growth is a massive change, one that, if it were to persist, would have wide-ranging consequences for employment, wage growth, and economic policy more broadly. For example, the frustratingly slow pace of real wage gains seen during the recent expansion likely partly reflects the slow growth in productivity

Some might think that a nine-year period is a sign of something persisting as it is only a year short of being another lost decade. For that not to happen now there would have to be quite a change.

Most recently, business-sector productivity is reported to have declined for the past three quarters, its worst performance since 1979.


This week will increasingly focus on US Federal Reserve policy as we approach the annual Jackson Hole symposium where more than a few policy changes have been announced. We will see both sides of the debate jostling for attention but Vice-Chair Fischer has other problems in addition to the ones I have mentioned so far. For example why did our “optimist” not join Esther George in voting for an interest-rate rise at the last meeting? Also why does our “optimist” feel the need to mention this.

that the U.S. economy could find itself having to contend at some point with negative interest rates–something that the Fed has no plans to introduce;

Surely in his world of rising interest-rates this is of no concern at all. Let us leave him singing along with Eminem and Dido.

The morning rain clouds up my window and I can’t see at all
And even if I could it’ll all be gray, but your picture on my wall
It reminds me, that it’s not so bad, it’s not so bad

Bank of England Brainwashing

I was concerned to note that there was clear evidence of this yesterday as West Han United fans sang along with the Bank of England theme song so enthusiastically!🙂

The Olympics

I am sad to see it end but there are dangers in bringing it into everything as Gideon Rachman of the Financial Times has illustrated today.

Obscure fact: Katarina Johnson-Thompson high jump of 5.98 in heptathlon would have won gold medal in individual women’s high jump

Actually she would have won the pole vault as well and would have saved on the pole! Even if we correct to 1.98 we have the problem that Thiam of Belgium also jumped it and is recorded as number one in the heptathlon high jump.




Debt monetisation by the Bank of England

Today sees the release of the latest public finances data for the UK and they have been genuinely changed by the Brexit Referendum. Some care is needed here as there is a clear and present danger of Brexit fatigue setting in as highlighted by RANSquawk yesterday.

minutes mention “referendum” 33 times!

However the genuine change I am referring to is the way that the leave vote has accelerated an existing trend towards lower borrowing rates for the UK government. We have seen UK Gilt prices surge and thus yields plunge with a couple of brief episodes of negative yields in the 3/4 year maturity region.

Bank of England

The Bank of England is currently doing its best to drive Gilt yields even lower and has undertaken 3 further rounds of  purchases of UK Gilts totalling some £3.51 billion this week alone. There will be no further purchases today because the bond buyers at the Bank of England find those 3 days to be so stressful and tiring that they then need a 4 day weekend to recover!

However the crucial point was made on Tuesday when Gilts maturing in the 2060s were purchased. You see the Bank of England bought at yields of 1.13% (2060), 1.14% (2065) and 1.15% (2068). A pittance or a mere bagatelle. It is hard not to have a wry smile at the shape of the UK yield curve these days but let me move on as that is something for those who have followed it for many years as I have. The fundamental point as I have been making in my articles on fiscal policy is that such yields completely change the position as we can now borrow for fifty years amazingly cheaply. Unless there has been a complete revolution in the UK inflation outlook then these represent negative real or inflation adjusted yields and quit possibly substantially negative ones. It was only on Wednesday that the RPI inflation index was recorded at 1.9% which means compared to it all of our Gilt yields are lower now and even the CPI is on its way up in spite of the effort to keep it low via the omission of owner-occupied housing.

Also there is the issue of the prices the Bank of England is paying which was 198,150 and 191 respectively for the 3 Gilts maturing in the 2060s. If it is to hold these to maturity then it will only get 100 back in nominal terms which is likely to be heavily depreciated in real terms. If it sells them along the way then it will require someone to pay more than what are record highs driven by it. On that road you get the QE to infinity argument or as Coldplay put it in the song trouble.

Oh, no, I see
A spider web, and it’s me in the middle,
So I twist and turn,
Here am I in my little bubble,

What can we actually borrow at?

Some care is needed as the Gilt market is plainly gaming the Bank of England as they know it has to buy to back up the words of its Governor Calamity Carney. Also the promises of its Chief Economist Andy Haldane as what use is an empty sledgehammer?

Yesterday we sold an extra £1.25 billion of our 2055 Gilt at a yield of 1.21% so if we look at infrastructure projects there must be at least some room for manoeuvre as I suggested on the 4th of this month.

So there is scope on that basis but my suggestion is that we start from the more micro level than the grand macro plans which have so let us down in the credit crunch era. Rather than money looking for projects let us go the other way and look for projects that we feel would genuinely be beneficial. I am open to suggestions but as I discussed only on Friday the UK’s power infrastructure seems to have plenty of scope for ch-ch-changes and improvement to me.

There were quite a few suggestions in the comments for those wanting to think more about this.

Debt monetisation

I raise the concept because whilst we are not seeing this in its purest form there are issues when the Bank of England buys Gilts in a maturity zone on a Tuesday and we sell one on a Thursday. Just to be clear it did not buy the 2055 Gilt and will not do so next Tuesday.

UKT 4.25% 2055 is excluded from the 23/08/16 operation because it has been auctioned by the DMO within one week of the purchase operation.

However when I worked in the Gilt market a lot of business was one Gilt versus another. Back then younger readers may be amused to learn that whilst there was some computer support I amongst others would do such calculations in our heads. How archaic and perhaps even antediluvian! These days though surely an algorithm style operation could do it in a millionth of a second. Now where does that leave the concept of debt monetisation? Not explicit but presumably implicit.

Today’s data

Nice to see a surplus and it was caused by July being a month for self-assessment income tax payments albeit a minor disappointment in the size.

Public sector net borrowing (excluding public sector banks) was in surplus by £1.0 billion in July 2016; a decrease in surplus of £0.2 billion compared with July 2015.

Here is a little more perspective.

Public sector net borrowing (excluding public sector banks) decreased by £3.0 billion to £23.7 billion in the current financial year-to-date (April to July 2016), compared with the same period in 2015.

The revenue situation seems to be responding to the economic growth seen.

This was around 3% higher than in the previous financial year-to-date, largely due to receiving more Income Tax, Corporation Tax and National Insurance contributions, along with taxes on production such as VAT and Stamp Duty, compared with the previous year.

In July itself it was particularly nice to see this as it has been a bone of contention for a while.

Corporation Tax1 increased by £0.6 billion, or 8.4%, to £7.5 billion

National Debt

It was hard not to have a wry smile at this part of the report.

This is the second successive month of debt falling on the year as a percentage of GDP and indicates that GDP is currently increasing (year-on-year) faster than net debt excluding public sector banks.

Chancellor George Osborne made a big deal out of that issue but despite various wheezes and not a little financial misrepresentation it remained elusive and outside his grasp. Now it arrives just after he gets the order of the boot. Life’s not fair as Lilly Allen reminds us.

Care is needed as it is only for two months so far. Also on the subject of misrepresentation we publish debt to GDP numbers that are on a different basis to other countries. This is not well explained by the media as many are unaware of it themselves, I still remember BBC Economics Editor Stephanie Flanders demonstrating poor knowledge of the subject matter. So having pointed out that Spain passed 100% yesterday here are comparable numbers for us.

general government deficit (Maastricht borrowing) in the financial year ending March 2016 (April 2015 to March 2016) was £74.5 billion, equivalent to 4.0% of GDP

general government gross debt (Maastricht debt) at the end of March 2016 was £1,649.2 billion, equivalent to 87.7% of GDP.


We find that the fiscal envelope of the UK has changed considerably in a short space of time. There is an irony that our patchy progress on the issue of our fiscal deficit, especially if you factor in the economic growth since 2013, has moved away from the front of the queue. The replacement has been the fact that we can now borrow so cheaply for the long-term and this provide plenty of opportunities as we note that the “bond vigilantes” are at least temporarily impotent.

However I counsel caution as if low bond yields and fiscal deficit spending were certain cures for the credit crunch malaise as many are now claiming then Japan would not be in the economic mess it is in would it? But we seem to be fulfilling at least a bit of what the Vapors promised.

I’m turning Japanese I think I’m turning Japanese I really think so
Turning Japanese I think I’m turning Japanese I really think so
I’m turning Japanese I think I’m turning Japanese I really think so
Turning Japanese I think I’m turning Japanese I really think so

The ECB faces a stronger Euro and an unbalanced economy

One of the features of this time of year is that the ECB (European Central Bank) is quiet as its Governing Council gets in some research on holiday hot-spots and does its best to boost the economies of the southern countries. However in their absence there is little sign of a summer lull this year so let us take a look at what is happening. Firstly of course we have the deposit and current account rate set at -0.4% and the 80 billion Euros of QE (Quantitative Easing) per month which now includes corporate bond purchases.

Negative Interest-Rates

Standard and Poors has produced a report on this issue and it starts badly for the ECB. From the FT.

Almost 500 million people are living under negative central bank interest rates – an unprecedented policy move which is “a clear sign of desperation” with a host of unintended consequences for the world economy, Standard & Poor’s has warned.

Almost enough to make Mario Draghi choke on his lunchtime glass of chianti. There is more.

It warned of the danger of a “feedback loop”, where negative rates encourage irresponsible and excessive risk taking that could spillover into escalating defaults that would require yet more stimulus from central banks.

There are two further problems which will be familiar to readers of my work.

This has led to concerns for pension funds and insurance companies, “reducing the investment returns these institutions rely on to meet their long-term liabilities”. They could then be spurred to search for yield by investing in riskier assets.


Should negative rates spread across the economy, it could lead to a “cash-only economy”: “This means increased transaction costs and rising risks of theft”

Then suddenly there is some better news for the ECB as Standard and Poors decides that it should fall into line with the IMF and tell us that this is working.

Negative rates in the eurozone are “having the desired stimulative effect”, managing to spur bank lending and leading to a sustained fall in the value of the euro.

Let us look at bank lending vis the ECB August Bulletin.

Loan dynamics remained on a path of gradual recovery………While the annual growth rate of loans to non-financial corporations (NFCs) recovered further in May, the annual growth rate of loans to households has remained broadly stable since February 2016.

Not entirely convincing is it? The truth is that the ECB has stopped such lending from falling but the numbers are barely positive.

The Euro

I was interested in the “sustained fall in the value of the Euro” claim as the Euro has been rising recently. The most obvious rise has been the post Brexit leave vote move against the UK Pound £ which has seen it push forwards to 1.15. However it has also been rising against the US Dollar and has pushed above 1.13 versus it this morning after the US Federal Reserve Minutes showed uncertainty last night. I guess it has absolutely surged against the Mongolian Tugrik which has required a 4.5% increase in interest-rates today to try to shore it up!

If we look at the effective or trade-weighted numbers we see that the Euro has been rising since it fell to just below 89 in early April 2015 and it is now 95.6. Or as Sober Look pointed out.

: ‘s tradeweighted euro index now highest since start of QE; has to be frustrating for the ECB –

If you are wondering why? I suspect that some figures released this morning give us at least a partial guide.

As a result, the euro area recorded a €29.2 bn surplus in trade in goods with the rest of the world in June 2016……In January to June 2016  the euro area recorded a surplus of €134.5 bn, compared with +€111.4 bn in January-June 2015.

As you can see whenever we are not in an ouvert crisis phase then there is steady and regular demand for Euros to pay for goods. Actually there is an elephant in this particular room as two thirds of the trade surplus in goods comes from one country Germany which recorded a 89.2 billion Euro surplus in the first half of 2016.  We are back to the view that I expressed some years back that the Euro is a vehicle for Germany to get a lower exchange-rate. The price for the other 18 nations is that they get a higher exchange-rate and this has compromised the economic performance particularly of countries like Italy and Portugal and of course especially Greece.

For all the media rhetoric and talk about Germany being a loser in the various Euro negotiations and bailouts it remains an enormous winner from its original currency devaluation. What it did not know back then was that we would see a post credit crunch era where a German Deutschmark would have soared.

The banks

The problem here is duofold. The first has been caused by the ECB itself and the way that negative interest-rates impact on the banking sector. An irony because of course so many policies are aimed at supporting the banks. Benoit Coeure of the Governing Council put it like this at the end of last month.

In the euro area, the potential adverse impact on bank profitability, if it materialises, would be compounded by low growth prospects and a legacy of high non-performing loans.

In fact virtually his whole speech was about the banks revealing his real interests! In essence on this road they are being given not far off “free money” from the QE program to offset losses elsewhere.

While average deposit rates only decreased by around 0.2 percentage point between June 2014 and May 2016, loan rates decreased by around 0.8 percentage point, effectively reducing the interest margin.

If we return to the lending figures I quoted early on you might reasonably have expected them to have done better in response to this.

The next problem is responded to rather euphemistically.

In the euro area, this translates into geographic differences based on national banking structures,

He means the banking travails of Portugal and Italy for example but does not want to say so explicitly. I note that Algarve News has reported this.

Portugal’s government has spent €14 billion of public money on ensuring the banking sector is ‘robust’ – but much of this money will never be seen again……….This overall €14 billion bill, as computed by the Court of Auditors and the National Institute of Statistics, represents nearly 8% of Portuguese GDP, hence Moody’s recent warning that the Portuguese banking system is one of the most fragile in Europe.

Even the traditionally insular US Federal Reserve is on the case.

However, European bank equities, especially those of Italian banks, underperformed, reflecting investor fears that lower interest rates will continue to weigh on profitability.

Not everywhere is on a downwards spiral as the economic growth spurt in Spain has helped improve things for banks there. This morning has seen a fall in non performing loans recorded although I also note that another consequence of the To Big To Fail strategy has also been seen as national debt to GDP which was 36% in 2007 looks like it has passed 100%.


There is much to consider for the ECB as it looks at its policies. It did originally manage a fall in the Euro exchange rate but as I have explained above that has been fading. As I have pointed out before both the main QE players right now ( Euro area and Japan) are seeing stronger not weaker exchange-rates these days. Actually one bit of relief for Mario Draghi and his colleagues has been that the Yen has risen even against the Euro.

Also whilst the economy is growing the rate of growth halved in the second quarter of 2016 to 0.3% from 0.6% previously. Whilst Spain has done well and Ireland has recorded some quite extraordinary numbers Italy and France recorded no growth at all in the latest quarter. I think that the ECB if Benoit Coeure is any guide is starting to think that it is struggling.

Fiscal and structural policies should act more decisively to support aggregate demand and productivity, thereby preventing the economy from falling into a low interest rate trap.

Yes especially in the struggling nations. Oh hang on the ECB as part of the institutions or troika has been enforcing exactly the reverse there!

Should the oil price continue to edge higher some of the gains from its lower phase will start to ebb away as well.