The last 24 hours have exposed several contradictions at the heart of what are the modern theories of central banking. These especially matter because central banks currently bestride the economic stage like Transformers with the debate being whether they are more like the good Autobots or the evil Decepticons. These days the loose monetary policy and enlarged balance sheets of the world’s major central banks mean that what was once analysis of financial markets has often become simply front-running the next central banking move. For example the early part of 2015 saw surges in Euro area bond markets and indeed negative yields at the shorter end of the maturity spectrum as investors and hedge funds front ran the expected QE (Quantitative Easing) purchases of the European Central Bank.
Central Banks target economic growth
This is a familiar theory and we see many examples of this being put forwards for policy for example in Europe, the UK and United States. But let me take you to Sweden where some good news this morning poses some real questions for the Riksbank.
Sweden’s GDP increased by 1.0 percent in the second quarter of 2015, seasonally adjusted and compared with the first quarter. GDP increased 3.0 percent, working-day adjusted and compared with the second quarter of 2014.
These are economic growth figures which would have been regarded as good even before the credit crunch made them look even better. The Riksbank expects this version of “Happy Days” to continue.
GDP is expected to grow more rapidly than normal in the years ahead and the labour market continues to improve.
So with us regularly being told that economic output is the driver for central banks these days we would expect some tightening of policy or at least a slowing of the easing. Er no.
All the board members considered it appropriate to increase purchases of government bonds by a further SEK 45 billion. Five members also advocated a cut in the repo rate by 0.1 percentage points to -0.35 per cent, ( 1st of July).
I note that Martin Enlund of Nordea has put it thus today.
: strong GDP doesn’t matter much for the Riksbank. Riksbank seeks higher inflation & higher wages, and isn’t getting it.
I think that it is too easy to say those crazy Swedes! So let us mark that strategy for a moment and progress.
What about inflation then?
This is one of the proclaimed objectives of the Riksbank right now and it is far from alone as the ECB and the Bank of Japan are also using it as major policy objectives right now. However no doubt more than a few of you are thinking to yourselves that this is convenient when inflation around the world is mostly below target, also should the current phase of commodity disinflation persist may hang around a little longer than previously expected. However in itself commodity price disinflation is likely to be temporary and therefore should be “looked through” in the manner described below. After all central banks are supposed to target consumer inflation around 2 years hence.
Back in October 2011 the Bank of England told us this.
The Committee’s view remained that inflation was likely to rise above 5% in the near term, boosted by already announced increases in utility prices.
So if it was applying the new philosophy of responding to current inflation it would have been tightening policy. Er no.
Overall, the case for an expansion of the Committee’s programme of asset purchases financed by the issuance of central bank reserves was compelling.
Instead they pursued a policy which was designed to push inflation higher and they decided that time was of the essence.
In terms of the timing of further asset purchases, there were clear arguments for acting quickly and decisively now that the need for further monetary stimulus had become clear.
As I pointed out at the time clear to whom exactly? They tried to push inflation higher to boost the economy but as I have pointed out many times on here the inflation overshoot led to a sharp drop in real wages which had a contractionary effect. If we consider that both main measures of UK consumer inflation went above 5% per annum then we saw one of the most extraordinary decisions by the Bank of England in my opinion, and I said so at the time.
The Bank of England should finance a further £75 billion of asset purchases by the issuance of central bank reserves,
However we get a very different view of central banking policy because back then an inflation divergence which is size was considerably more than being seen by the Riksbank now was ignored and overlooked. Back then some members of the UK Monetary Policy Committee embarked on a desperate search to find more “helpful” inflation measures only usually to abandon them too as they also rose.
Accordingly we see that “current inflation” can be ignored too as central banks switch not only how important inflation is but whether they choose to concentrate on present or future (at the forecast horizon) inflation.
The Labour Market
If we think back this was an easy target for central banks because unemployment rose and wages fell in response to the credit crunch impact. Thus they were aligned with economic output and it was easy at least initially to justify monetary easing in response to this. However in more recent times using unemployment as an indicator has misfired. From the US Federal Reserve on the 12th of December 2012.
at least as long as the unemployment rate remains above 6-1/2%,
Whilst one might argue that there was no promise to act exactly at 6.5% there is the counterpoint that if you focus attention on a particular level then it is embarrassing to say the least when it surges below it and you do nothing! Currently the US unemployment rate is 5.3% and the Fed has done nothing. The Bank of England had the same problem with a 7% unemployment rate and such policy statements were redacted.
So we now have concentration on the vague concept of “slack” with a soupcon of underemployment thrown in. Also we see emphasis on wage growth which for those who worry that it was in decline pre credit crunch there are genuine fears that this could lead “To infinity… and beyond!” style policies.
What about the US Federal Reserve?
Last night brought something very familiar which was food for both sides of the debate. Let me open with the case for an interest-rate rise.
The labor market continued to improve, with solid job gains and declining unemployment…..as the labor market improves further
Whilst on the other side of the coin we have.
Inflation is anticipated to remain near its recent low-level in the near term, Market-based measures of inflation compensation remain low;
So I doubt many were swayed by this although I note that market expectations for a rise in September have followed what happened to similar expectations for March and June. It remains “just around the corner” apparently.
As you can see the central banking playbook has not only been torn up there is little sign of this from Montell Jordan.
This is how we do it
Although mind you some will see echoes of central banking behaviour in some different lyrics from the same song.
But now I’m a big G. The girls see I got the money
A hundred-dollar bills y’all
Ah those happy days when “hundred-dollar” bills were an aspiration of wealth and value! But as I have pointed out today central banking policy is a movable feast between output, the labour market and inflation with more than a soupcon of currency wars thrown into the mix. The US Federal Reserve is quiet about the rise in the US trade-weighted index from 77 to 92 (Via FRED) over the past year. Although on the other side of the coin Brazil last night fired another salvo in a different strategy.
Brasilia – Evaluating the macroeconomic scenario, the outlook for inflation and the current balance of risks, the Copom decided unanimously to raise the Selic rate by 0.50 pp to 14.25% pa, without bias.
So my summary of central banking policy right now comes from OMC.
How bizarre, how bizarre
It’s making me crazy
(It’s making me crazy)
Odd in a world of Forward Guidance isn’t it?