The Deputy Governor of the Bank of England acts like Mr.Bean whilst the IMF is full of praise for the UK’s austerity

After Friday’s surge in world equity markets yesterday saw a little indigestion with the Dow Jones Industrial Average falling some 48 points to 10812. This morning has seen concerns about tomorrows Tankan survey in Japan (where the Bank of Japan surveys economic conditions) lead to a fall in the Nikkei 225 equity index of 107 points to 9495. This means that the spread between the two indices has widened further to 1317 points. One cause of the discrepancy the recent Yen strength that led to Bank of Japan intervention has been quieter the last 24 hours or so and has remained around 84.20.

Japan’s Government Bond Market

The recent moves in Japan to intervene against the currency combined with fears about the impact of its rally has impacted on the Japanese government bond market. We can also add another reason for recent gains which was Prime Minister Kan defeating the leadership  challenge he was subjected too as he was considered to be the most fiscally conservative candidate.The combination of these factors has led to ten-year Japanese Government bond yields falling to 0.96%. Today there was an auction of 2 year bonds which had a coupon of 0.1% and were issued at a price of 99.92, not much return there is there? Just to add to the enigma that is Japan this is the place with a national debt to GDP ratio of over 200% and rising.

Channel Four interviews Mr.Bean

There was a rather extraordinary interview given by Charlie Bean yesterday to Channel Four news. This leads to obvious headlines like Deputy Governor is Mr Bean with the implications of the hapless comedic character played by Rowan Atkinson and with the speech he gave the image is not so far wrong.

What did he say?

“What we’re trying to do by our policy is encourage more spending. Ideally we’d like to see that in the form of more business spending, but part of the mechanism … is having more household spending, so in the short-term we want to see households not saving more but spending more’.

 “It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

“Savers shouldn’t see themselves as being uniquely hit by this. A lot of people are suffering during this downturn … Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.”

The Deputy Governor said the Bank’s 0.5  per cent base rate was part of an “aggressive policy” to deal with a “once-in-a-century” financial crisis. He continued with the theme that he felt that savers should eat into their capital. Furthermore he also said that he said he “fully sympathised” with the plight of older people who depended on their savings, but then added that they had enjoyed high interest rates in the past and had seen huge rises in property values in a rather patronising addition.

Comment

I am sure that this intervention will make many savers blood boil and I notice one reply which pointed out that it was much easier for a man with a guaranteed index-linked pension to make such suggestions than someone struggling to get by. However let us look at what the Deputy Governor is saying. He wants savers to spend to help boost consumption in the economy. Indeed when asked this question.

This bad news for savers is the point of what you are doing?

He replied “yes”. Now there are two sides to the balance sheet and let us consider the moral hazard the Deputy Governor has leapt into.

1. He expects savers to be rational and to think ahead for better times for them and to spend now in advance of this (in spite of telling them interest rates will be low for a long time in something of a contradiction).

2. Yet he continually bails out borrowers and does not expect to expect them to shoulder any of the burden as there was no mention of them at all.

We now get to the Bank of England’s view of the “paradox of thrift”. Apparently Mr.Bean after telling people to save for years now wants them to spend just at the moment it looks as though people may be willing to save. He is afraid of the consequences of them saving but is apparently not bothered by the implication of his words that the Bank of England will bail out borrowers. On that basis if savers are as rational as he thinks then they will see that saving under his regime is unlikely to be rewarded and if they follow this tenet the he has managed to accelerate the next crisis as in case he has forgotten one of the causes of current problems was too much borrowing and too little saving! He will solve the problem of this being a “once-in-a-century” but not in a good way.

Mr.Bean revealed that savers often wrote to the Bank of England,after his words I hope the postman/woman does not have a bad back.

The International Monetary Fund is full of praise for the UK’s austerity programme.

A provisional report from the IMF on the UK must have sounded like Chancellor George Osbourne’s favourite music yesterday. He would have struggled to write a better one himself.

Economic recovery is underway, unemployment has stabilized, and financial sector health has improved. The government’s strong and credible multi-year fiscal deficit reduction plan is essential to ensure debt sustainability. The plan greatly reduces the risk of a costly loss of confidence in public finances and supports a balanced recovery. Fiscal tightening will dampen short-term growth but not stop it as other sectors of the economy emerge as drivers of recovery, supported by continued monetary stimulus……………

Our central scenario envisages real GDP growth of 2 percent in 2011, rising gradually to 2½ percent in the medium term

As Mr. Osbourne starts to read the good news even his Office of Budget Responsibility which has had teething problems gets praise.

The establishment of a new independent Office for Budget Responsibility (OBR) is a welcome step toward strengthening the budget process

The conclusion is full of praise too.

With steadfast fiscal adjustment, forward-looking monetary policy aimed at achieving the inflation target, and gradual implementation of strong financial sector reforms, economic fundamentals should strengthen and establish the basis for sustainable recovery.

Comment

One needs to remember that the IMF is an organisation which often recommends austerity programmes to nations so it was always likely to approve Chancellor Osbourne’s willingness to don a fiscal “hair shirt”. It probably would have had some praise for ex-chancellor Darling’s plans too. Also it is also true that it as an organisation is by no means infallible and currently has problems with its strategy in Latvia and Hungary and to my mind Greece too. I have criticised it in the past for having the same answer to all problems and this report is another indication of that line of thought.

Tucked away in the report on the section on the Bank of England’s monetary policy is this section and the emphasis is mine.

With inflation projected to fall back to target over the policy horizon, the Bank of England’s accommodative stance reflects the need to maintain overall policy stimulus as fiscal tightening takes hold and financial intermediation normalizes only gradually……..Conversely, the central bank must stand ready to start a gradual tightening if output recovers apace and inflation continues to surprise on the upside.

Here we see two plain flaws. The Bank of England virtually always predicts inflation will fall back to target over the policy horizon but as I have discussed many times before its problem is that inflation does not do as it is told and has consistently exceeded its target (41 out of the latest 50 months). Accordingly the phrase has little meaning or relevance. Also inflation surprises have not led to any policy tightening so the section on the Bank of England lacks intellectual credibility. One section I do agree with is.

Developments in labor costs, other input prices, and inflation expectations warrant particularly close monitoring.

If you think about it this sentence tells you that the IMF has its concerns too.

Ireland, Portugal and the European Financial Stabilisation Fund

One or two of the news services are having problems with the government bond yields in Ireland and are over-stating them. Her ten-year yield is at 6.63% and rose on a day when other were falling for a poor day. Portugal is not far behind at 6.55% on the same measure. There were rumours yesterday that the European Central Bank had looked at a bailout for Ireland which if true should never have been released. I was asked a question about the EFSF yesterday and would like to put here my view of some of the problems with it. The full version is in the comments section but here is how it would operate and I am sure that many of the potential flaws are plain to see.

“A eurozone member state seeking financial assistance must initially agree a Memorandum of Understanding (MoU) with the European Commission, in liaison with the IMF and the ECB. This MoU will set out the budgetary and economic policy conditions which the eurozone member state must comply with in order to receive financial assistance. The detailed terms and conditions would then be set out in a Loan Facility Agreement which is subject to the agreement of all the guarantors (i.e. those countries in the EFSF). The company running the EFSF will be responsible for raising the funds it requires to advance the loans to the borrower.”

As I pointed out it is hardly likely to be Mr.Speedy. It is a deal for bureaucrats and officials rather than something which can act quickly.

 

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26 thoughts on “The Deputy Governor of the Bank of England acts like Mr.Bean whilst the IMF is full of praise for the UK’s austerity

  1. Great post as ever Shaun. I nearly emailed you about that Mr Bean email as I couldn’t believe the man who has one of the votes on interest rates was speaking like that on Channel 4 last night!

    The interview basically confirmed my hunch that they have no plan b and we are like the titanic slowly sailing into an Iceberg only in the middle of the day with clear visibility!

  2. “…the IMF is full of praise for the UK’s austerity.”

    What austerity? The UK government’s spending review isnt even due for publication until late October. How can there be praise for something which is currently only supposition and rumour?!

    Politicians being what they are, I am very doubtful of any meaningful “cuts” in public spending to come. Yes, Im sure the headlines will speak of their severity but in truth Mr Cameron and friends will always have one eye on securing their own positions. And that will lead to any meaningful cuts always being re-thought and re-jigged when out from under the media spotlight.

    As for the IMF.. what else would we really expect them to say? The whole statement is a joke!

    Zak.

    PS. Yes I am a saver and Yes I am more than just a little bit miffed at current BoE policy decisions. But what can I do about it? Nothing!

  3. Well, at least Mr Bean came close to being honest: we are going to keep real interest rates at minus 4.5% on the RPI measure, in order to screw the little people into spending their capital. Would that Ed Balls and others were so up-front about their policies.

  4. Shaun, so finally after lying for months (about 18), they come clean, and credit to you, you said that it was either incompetence on a grand scale or deliberate policy. Maybe they are pretending now that it was deliberate as the alternative is to admit Mr. Bean-like incompetence.

    Is is not true that inflation could end up getting out of control with this policy and hence even the over leveraged borrowers that Beano is trying to protect will get crushed with 10% mortgages

    • Certainly a possibility if they end up taking belated action to tackle inflation. I fear however that intend not to take action under any given level of inflation.Perhaps they intend to allow it to go for far as double figures and believe that some element of self regulation (as demand declines) will occur.

      They would of course be looking into the jaws of a Weimar situation.

    • It is not much of a choice is it? To be accused of incompetence or deliberate misrepresentation.

      If we return to the basic inflation/disinflation argument we find ourselves back on one of my themes. If we add Adam Posen’s speech to the mix we find that their speeches are confirming one of my arguments that the Fed and the MPC will use everything that they can to prevent deflation/disinflation and this to my mind has always made inflation more likely and if they get it very wrong something more like hyper-inflation.Back to Elvis costello’s pump it up…. If we get deflation/disinflation we will be in quite a mess because whatever ammunition we have will have been used up.

      Also it brings to mind my theme that central banks are meddling in too much at once not always particularly competently. As it happens as this news was breaking I was busy thinking about the dollar/yen exchange rate which at 83.73 which if I may be forgiven for lapsing into foreign exchange trader speak is saying “do you want some or what?”. I still hold to the argument that intervention is at best a temporary solution and at worst may make things worse.

  5. The current orthodoxy is public sector cuts accompanied by (however you want to phrase it) accommodative monetary policy. That’s the Govt/BoE approach, it’s what the CBI want and also the IMF agree with it.

  6. Straight from the Bank of England’s website –

    ‘The Bank has a statutory objective to “contribute to protecting and enhancing the stability of the financial systems of the United Kingdom”.’

    This is an objective that the MPC are also bound to work towards. Of course, this is currently in conflict with the MPC’s other objective –

    ‘One of the Bank of England’s two core purposes is monetary stability. Monetary stability means stable prices – low inflation – and confidence in the currency. Stable prices are defined by the Government’s inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee.’

    It is my guess that the MPC are terrified of the consequences of a house price crash for the UK’s banking system, and are therefore focusing on the first of their two conflicting objectives for the moment. Perhaps they should be banned from placing index linked gilts in their pension fund to focus their minds on the second objective as well.

    • PS. Evidence for the importance of house prices to the MPC’s decision making: August was the month that it became clear that the house price recovery of Q2 2009 to Q2 2010 has run out of steam – there have been a number of reports of poor August mortgage lending figures over the last month. It is also worth remembering that in early 2009 when QE I was embarked upon, rates had been slashed to nothing and the housing market was still in free fall. It will be interesting to see whether the CML can pressure the government into extending some kind of support for the £300 billion gap in wholesale mortgage funding (SLS due to expire early 2011).

  7. Hi All,
    It would be worthwhile reading Adam Posen’s speech he has just given in Hull. I quote

    ” Instead, comparable experience tells us that persistent high unemployment and output gaps are the major threat to both price stability and to our long-term potential, that persistently slow
    growth erodes aggregate supply and future growth, that a globally synchronized downturn for 50% of the world economy is going to be worse than one which hits only one country or region, and that a great deal of unconventional monetary stimulus will be needed to have a major impact when the financial system remains dysfunctional and risk aversion is very high. That is the case for doing more now.”

    Forget about QE Lite – he reckons we need QE Full Mk 2 – he is very dismissive of overheating arguments, and thinks we face the reverse and Japan’s experience unless we take further action. He leads in to the possibility of more ( not less) fiscal stimulus from Government and talks about societies becoming destabilised……an alarm bell sounds.

    • “a great deal of unconventional monetary stimulus will be needed to have a major impact when the financial system remains dysfunctional”

      Would it not make more sense to try to fix the aforementioned dysfunctional financial system, rather than hosing the economy down with money? Still, when you have a hammer…

    • “If there was going to be a recovery that either was inflationary or otherwise meaningfully different from that established pattern, it should have been evident by now. Absent evidence of a truly different recovery, the analysis of mainstream macroeconomics should apply …That proven analysis tells us that, under the present circumstances, sustained high inflation is not a threat …”

      A) What we have done hasn’t worked.
      B) We don’t know what we have done.
      C) Let’s try it again, there’s no risk.

    • Hi Shireblogger
      I would just like to point out that when i said last night in a reply to you on here “I have remarked before on QE that there is no great need to put too much time into the MPCs explanations of it as like as a bus a new one will soon be along….. Somewhere in there is why they are struggling to get the message across combined with a failure to hit their inflation target.” that I did not know about Adam Posen’s speech!

      I will discuss it more fully in my next update but one immediate thought that I had was that he has broken the convention that MPC members do not reveal their voting intentions before a meeting. If he does not vote for more QE next week after saying in his speech “Please allow me to conclude with why I believe that we should do more quantitative easing now
      in the UK.” then those at the speech will wonder if he is simply full of hot air. I know the convention applied to interest rate moves but in these times should also apply to QE moves. If I was the Governor I would ask to have the power to see and edit his speeches in future…

      • I must I confess I was surprised at his candour. I note that he has recently returned from Washington and his further suggestion in this speech that further QE should be global, the Fed and BoE working together I wonder……

        • I do not know if he speaks to Mr. Bullard but he has been implying similar things. For those reading this unware of the situation Mr.Bullard is a member of the FOMC so is on the committee which sets America’s monetary policy. I wrote about him on the run-up to the August FOMC Meeting as he had given a speech which has some parallels with Mr. Posen’s new view. That meeting led to the new policy of monthly Treasury Bond purchases or QE-lite in the US as previously purchased securities mature.

      • An American giving an opinion that agrees with the Fed after having a meeting with them!
        Smacks of Mr Posen being an American mole, working for them not us. All part of the money and currency war.

        • Hi KG
          I did see one amusing comment which suggested that in future we might perhaps choose Germans rather than Americans……with apologies to any Americans reading this as I know by no means all think alike.

  8. The Bank of England is not bailing out borrowers, or if it is only to the extent that it is actually bailing out lenders. Although, contradicting myself immediately, the biggest borrowers are companies in the financial sector rather than households. (Source: http://www.direct.gov.uk/prod_consum_dg/groups/dg_digitalassets/@dg/@en/documents/digitalasset/dg_188581.pdf page 7 refers).

    QE to date hasn’t really done anything to help people stay in their homes except as a bi-product of supporting the banks.

    It is unclear to me how QE2 along the same lines of QE1 is going to be a successful policy when the private sector is deleveraging.

    • Hi SB

      …so negative interest rates in real terms are not bailing out those that were allowed to borrow beyond their means? really!?

      Whether or not people are or are not still in there homes as a result of the effects of QE is, I feel, also questionable. Unfortunately that “can” has been kicked so far down the road that it is now very hard to imagine what would have happened to the banks (and the UK housing market) had QE not been undertaken in the first place.

      Zak.

      • I don’t think it does bail them out it just allows them the opportunity to pay the debt down.

        Yes it is questionable that people have been able to stay in their homes. But I couldn’t rule out entirely that with smaller QE or even none at all that banks actions may have been more severe.

        My imagination on the last point is that we would have been in a worse position today – in that we could still have banks eyeing each other suspiciously in terms of their ability to repay short term loans.

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