Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.


There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.


An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.


This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?

Could US fiscal expansionism lead us to QE4?

The credit crunch era has been one where monetary policy has taken centre stage. There are many ways of expressing this but one is that technocrats ( central bankers) have mostly run the economic show as elected politicians have chosen to retreat to the sidelines as much as possible. Whatever you may think of President Trump he is not someone who is happy to be on the sidelines as he has exhibited publicly once or twice with some pushing and shoving. But more importantly we are seeing something of a shift in the balance of US economic policy as the monetary weapon gets put away at least to some extent but the fiscal one seems to be undergoing a revival.

A relatively small reflection of this was last night’s budget deal. We have become used to talk of a US government shutdown followed by an eleventh hour deal and no doubt there is a fair bit of both ennui and cynicism about the process. But as the Washington Post notes as we as giving the national debt can another kick there was this in the detail.

According to outlines of the budget plan circulated by congressional aides, existing spending caps would be raised by a combined $296 billion through 2019. The agreement includes an additional $160 billion in uncapped funding for overseas military and State Department operations, and about $90 billion more would be spent on disaster aid for victims of recent hurricanes and wildfires.

An increase in military spending was a Trump campaign promise so it is no surprise but spending increases come on top of the tax cuts we saw at the end of last year.

The Trump Tax Changes

According to the US Committee for a Responsible Fiscal Budget there was much to consider.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years, leading debt to rise to between 95 percent and 98 percent of Gross Domestic Product (GDP) by 2027 (compared to 91 percent under current law). However, the bill also includes a number of expirations and long-delayed tax hikes meant to reduce the official cost of the bill. These expirations and delays hide $570 billion to $725 billion of potential further costs, which could ultimately increase the cost of the bill to $2.0 trillion to$2.2 trillion (before interest) on a conventional basis or roughly $1.5 trillion to $1.7 trillion on a dynamic basis over a decade. As a result, debt would rise to between 98 percent and 100 percent of GDP by 2027.

This is a familiar political tactic the world over where the numbers depend on others taking the difficult decisions in the future! One rather sneaky move is the replacement in terms of income tax thresholds of inflation indexation by the US Consumer Price Index by the chained version which is usually lower. So jam today but more like dry toast tomorrow.

Won’t this boost the economy?

There are enough problems simply doing the direct mathematics of government spending and revenue but the next factor is how do they effect the economy? Well the US Congress has given it a go.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window. That
increase in output would increase revenues, relative to the conventional estimate of a loss of $1,456 billion over that period by about $451 billion. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $66 billion over the budget

The idea of tax cuts boosting the economy is a reasonable one but the idea you can measure it to around US $451 billion is pure fantasy. To be fair they say “about” but it should really be if you will forgive the capitals and emphasis “ABOUT“. Anyway for the moment let us move on noting that there is already a fair bit of doubt about the impact on the US deficit over time from US $1 trillion or so to a bit over US $2 trillion.

What is the deficit doing?

According to the US CBO ( Congressional Budget Office) it has been rising anyway in the Trump era.

The federal budget deficit was $174 billion for the first four months of fiscal year 2018, the Congressional
Budget Office estimates, $16 billion more than the shortfall recorded during the same period last year.
Revenues and outlays were higher, by 4 percent and 5 percent, respectively, than during the first four
months of fiscal year 2017.

As you can see revenues are doing pretty well and in fact are being led by taxes on income being up by 8%. However spending rose even faster at an annual rate of 5% which at a time of economic growth gives us food for thought. There was one curious detail and one familiar one in this.

Social Security benefits rose by $11 billion (or 4 percent) because of increases both in the number of beneficiaries and in the average benefit payment.

That seems odd at a time of economic growth but the next bit reminds us that the rise in inflation has a cost too due to index-linked bonds called TIPS.

Outlays for net interest on the public debt increased by $13 billion (or 14 percent), largely because of differences in the rate of inflation.

More Spending?

It looks as though we will find out more about the much promised infrastructure plan next week. From Bloomberg.

President Donald Trump expects to release on Monday his long-awaited plan to generate at least $1.5 trillion to upgrade U.S. roads, bridges, airports and other public works, according to a White House official.

How much of this will come from the government is open to debate. The modern methodology is to promise some spending ( in this case US $200 billion) and assume that the private-sector will do the rest. One of the more extraordinary efforts on this front was the Juncker Plan in the Euro era which assumed a multiplier of up to twenty times. But returning stateside we can see that there will be upwards pressure on spending but so far we are not sure how much.


In my opening I suggested that the United States was switching from monetary expansionism to fiscal expansionism. Let me now introduce the elephant in this particular room.  From the Atlanta Fed

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2018 is 4.0 percent on February 6, down from 5.4 percent on February 1.

They may well be somewhat excitable but if we look at the 3.2% predicted by the New York Fed the view is for pretty solid economic growth. So the fiscal position should be good especially if we add in the fact that for all the media hype treasury bond yields are historically still rather low. Yet none the less the fiscal pump is being primed. Or to put it more strictly after a period of pro-cyclical monetary policy we now seem set for pro-cyclical fiscal policy.

There are obvious implications for the bond market here as there will be increases in supply on their way. No doubt for example this has been a factor in pushing the thirty-year bond yield above 3%. You might have expected more of an impact but I am increasingly wondering about something I suggested some time ago that the path to higher interest-rates in the United States might be accompanied by QE4 or a return to bond buying by the US Federal Reserve. Should the economy slow at any point which would boost the deficit on its own then we could see it. Also this could be a factor in the weaker US Dollar as in is it falling to reflect the risks of a possible return to Quantitative Easing?

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?

Me on Core Finance TV




Fiscal policy was on the march at Jackson Hole

Over the weekend many of the world’s central bankers were guests of the Kansas Federal Reserve in Jackson Hole Wyoming. In terms of location I believe it was chosen because a previous chair of the US Federal Reserve Paul Volcker was a keen fisherman. However this late August symposium has become one which influences the economic winds of change as central bankers discussed easing policy in response to the credit crunch and in more recent times a speech was given on what were perceived to be the wonders of Forward Guidance. Michael Woodford was very clever in suggesting to a group who wanted to believe that they could influence events via mere speaking or what has become called Open Mouth Operations.

I shall argue that the most effective form of forward guidance involves advance commitment to definite criteria for future policy decisions.

They are still at that today to some extent although the definite criteria theme has mostly been ignored especially in the UK where it went wrong for the Bank of England almost immediately.

What about now?

The problem for the central bankers is that to coin a phrase that monetary policy may be “maxxed out” or as it is put more formally below.

despite attempts to set economies on normalization paths after the Great Recession and the Global Financial Crisis, the scope for countercyclical monetary policy remains limited: benchmark interest rates have continued to hover near or even below zero.

This is from a paper presented on Saturday by Alan Auerbach and Yuriy Gorodnichenko of the University of California Berkeley. In their conclusion they go further.

Although economists do not believe that expansions die from old age, the prolonged U.S. expansion will end sooner or later and there is serious concern about the ability of policymakers in the United States and other developed countries to fight the next economic downturn. Indeed the ammunition of central banks is much more limited now than before the Great Recession and it is unlikely that expansionary monetary policy can be as aggressive and effective as it was during the crisis.

Actually if monetary policy had been effective the paper would not be necessary as the various economies would have responded and we would be on a road where interest-rates were say 2/3% and central bank balance sheets were shrinking, In reality such interest-rates to quote Star Wars are “far, far away”.

Fiscal policy

If monetary policy has less scope for action then our central planners face being irrelevant so they will be grasping for an alternative and fortunately according to our two valiant professors it is at hand.

With tight constraints on central banks, one may expect—or maybe hope for—a more active response of fiscal policy when the next recession arrives.

The problem with this the familiar theme of the “bond vigilantes” turning up.

It is certainly conceivable (see e.g. Aguiar et al. 2017) that a significant fiscal stimulus can raise doubts about the ability of a government to repay its debts and, as a result, increase borrowing costs so much that the government may find its debt unsustainable and default.

This of course was last seen on a major scale in the Euro area crisis particularly in Greece, Ireland, Portugal and Spain. Of course the European Central Bank intervened by buying bonds and later followed another part of Michael Woodford’s advice by introducing a larger and more widespread QE or bond buying program. So we have seen central banks intervening in fiscal policy via a reduction in bond yields something which government’s try to keep quiet. We have individual instances of bond yield soaring such as Venezuela but the last few years have seen central banking victories and defeats for the vigilantes. In another form that continued this morning as I note that a North Korean ballistic missile passed over Japan but the Nikkei 225 equity index only fell 87 points presumably influenced by the way that the Bank of Japan buys on down days.

What about more overt fiscal policy?

Apparently this can work.

We find that in our sample expansionary government spending shocks have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs (interest rates, CDS spreads). This result obtains especially when the economy is weak. In fact, a fiscal stimulus in a weak economy may help improve fiscal sustainability along the metrics we study.

Indeed this for them is essentially a continuation of past work.

This constraint on monetary policy coincides with a resurgence in activist fiscal policy (Auerbach and Gale, 2009), which has moved from a focus on automatic stabilizers to a stronger reliance on discretionary measures, reflecting not only necessity but also growing evidence of the effectiveness of such policy to fight recessions (e.g., Auerbach and Gorodnichenko, 2012, 2013).

Also I am reminded that we should never believe something until it is officially denied.

Given the nature of the sample analyzed, our results should not be interpreted as an unconditional call for an aggressive government spending in response to a deteriorating economy.

The UK

Jonathan Portes who is an advocate for fiscal policy has written this in Prospect Magazine.

The answer is very technical—£100 billion or so of the extra debt relates to the Bank of England’s Asset Purchase Facility. Briefly, the BoE makes loans to banks and buys corporate bonds, in return for cash (“central bank reserves”).

He suggests that as this has been mostly ignored( not on here) we could borrow for other purposes.


There is a fair bit to consider here as I note that North Korea has done its bit as bond markets have risen today and yields fallen. For example the UK ten-year Gilt yield has dropped to 1% giving us food for thought with inflation at either 2.6% ( CPI) or 3.6% ( RPI). A clear factor in the expected push for fiscal policy is that bond yields are so low as conventional UK Gilt yields do not go above 1.7% and other countries such as Germany Switzerland and Japan can borrow for much less. Against such bond yields theoretical analysis is always likely to look good so the first issue is whether they would be maintained in a fiscal expansion. Or to put it another way are central banks being asked here for a type of QE to infinity?

Next is the issue of how a fiscal stimulus is defined as for example countries which have stopped borrowing and run a surplus like Germany and Sweden are relatively rare. Most have continued to borrow and run annual fiscal deficits albeit usually declining ones. Thus the ballpark seems to have shifted to increasing deficits rather than having one at all which is the sort of “junkie culture” road that monetary policy went down. If we look back to a past advocate of fiscal stimulus John Maynard Keynes he was also someone who suggested that when the growth came there would be a period of payback.

What we also find ourselves mulling is the difference between the specific and the general. I am sure that everyone can think of a project that would provide plenty of benefits and gains but as we move to a more generalist position we find ourselves facing a reality of Hinkley Point and HS2. To be fair our two professors do acknowledge this.

Bridges to nowhere, “pet” projects and other wasteful spending can outweigh any benefits of countercyclical fiscal policy.

As a conclusion the Ivory Tower theory is that fiscal policy will work. There are two catches the first is that if they were even regularly right we would not be where we are. The next is that on some measures we have been trying it for quite some time.

In reality the establishment seems likely to latch onto this as we have discussed before.



The establishment switches from monetary to fiscal policy

It was only yesterday that I was analysing the way that the Bank of England Governor was playing a game with the media. Today I wish to look at another issue where so many of those who told us that we needed ever more extraordinary monetary policy measures have changed their tune. For example a couple of years or so ago Governor Carney was assuring us that monetary policy was not “maxxed-out” but now he seems to be shuffling in that direction. Recently the Bank of England produced a working paper on itself which concluded it had been doing a good job.

It finds reasonably strong evidence of QE having had a material impact on financial markets, generating a significant loosening in credit conditions. There is also evidence of QE having served to boost temporarily output and prices, in a way not associated with other central bank balance sheet expansions.

Yet there is little sign of balance as the bad bits are simply ignored and put at the back of the darkest cupboard they could find.

This leaves to future research important issues such as the impact of a reversal in QE policies and the distributional consequences of QE.

Actually the Bank of England has suggested that the distributional consequences of QE are the responsibility of government as it sings along to Shaggy.

It wasn’t me……It wasn’t me

However there are a litany of issues here. Firstly the very concept of QE had fiscal elements to it. These were that it required treasury permission and that it made it cheaper for governments to borrow and loosened fiscal policy for them via lower bond yields.

Indeed you could argue that elements of what has been called monetary policy is simply a transfer to companies or another type of fiscal policy. For example this from the ECB (European Central Bank).

Corporate bonds cumulatively purchased and settled as at 28/10/2016 €37,815 (21/10/2016: €35,886) mln

Or this from this morning’s statement from the Bank of Japan.

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.

It is fast becoming the Tokyo Whale.

A Further Shift

Now rather than elements of fiscal policy being tucked away in monetary policy it is now emerging blinking into wider media exposure. Sadly there is virtually no challenge made about the fact that all the extraordinary monetary measures were supposed to rescue us. Below are the words of the former IMF Chief Economist Olivier Blanchard on the subject/

I think there is fiscal space in nearly every country.

Sadly they do not ask why as part of the IMF he applied fiscal austerity to places like Greece and Portugal and then did a complete U-turn on the subject. But there is something almost as extraordinary.

Take a country like Spain. They have a 100% debt-to-GDP ratio, a bit more. Investors don’t seem to be very worried. They think that is sustainable. Now suppose Spain decides to do a really big public investment program. So they decide to spend 2% more of GDP for two years. This is big. This is major fiscal expansion. With the multipliers, GDP goes up, so in fact spending 2% more, they get 1% in revenues so this increases the debt-to-GDP ratio from a 100% to 103%. Do you run for cover? No, I am quite sure they do not.

There are a whole litany of issues here. Firstly the economic news from Spain is very good right now with annual GDP growth at 3.2% so why does it need public investment as well? Spain had lots of investment pre credit crunch which led it to trouble and an economic cul-de-sac which our latter-day Dr.Pangloss ignores.

So the whole issue is whether governments spend the money right.

A bit like Portugal’s roads to nowhere. Also it is extraordinary that “Investors don’t seem to be very worried.” was unchallenged as the main new investor now is of course the ECB which has bought some 126.4 billion Euros and rising of Spanish government bonds.

Oh and on the subject of another crossover between monetary and fiscal policy I think he was right first time.

Yes. Initially I thought the proposal by [Harvard Professor] Ken Rogoff, among others, to basically eliminate cash was insane. But maybe it is less crazy than I thought.

World Economic Forum

This has entered the fray today with this from Chatham House ( originally written in September).

It is time for fiscal stimulus to gradually assume more of the burden of propping up a global economy that still looks worryingly fragile.

Really why? That seems to be missing. All we get are some political statements including an implication rather rare in these times that Donald Trump may be on one right track. What is missing is any analysis of why we are here?

The Bank of Japan (BoJ), which in 1999 became the first central bank to cut rates to zero, looks set to be the first to signal that monetary policy is approaching its frontier.

In the “lost decade” period Japan has had a lot of fiscal policy and is adding to existing stimulus as it has run fiscal deficits so we are back to “More, more, more” with no explanation of why it will work this time when it has not done so before.

Stanley Fischer

For a man who is apparently just about to raise interest-rates the Vice Chair of the US Federal Reserve spends a lot of time discussing stimulus measures! I have written before about how frequently he denies that he has any plans to introduce negative interest-rates. Well now he seems to be advocating expansionary fiscal policy.

Over the years, many economists–some of them textbook authors–have noted that expansionary fiscal policy could raise equilibrium interest rates. To illustrate this possibility, the next two bars on the slide show the estimated effect on interest rates of two possible expansionary fiscal policies, one that boosts government spending by 1 percent of GDP and another that cuts taxes by a similar amount. According to the FRB/US model, both policies, if sustained, would lead to a substantial increase in the equilibrium federal funds rate. Higher spending of this amount would raise equilibrium interest rates by about 50 basis points; lower taxes would raise equilibrium rates by 40 basis points.


So we see a shift towards fiscal policy here too. Will this Stan be like the one described by Eminem?

Well, gotta go, I’m almost at the bridge now
Oh sh*t, I forgot, how’m I supposed to send this sh*t out?
[car tires squeal][CRASH]
.. [brief silence] .. [LOUD splash]


The fundamental point is that we were led into a trap by those who argued for extraordinary monetary polices. Nearly eight years down the road there has been so little progress that we are seeing much more additional easing than any reversal or tightening. The US Federal Reserve opened 2016 hinting at “3-5” interest-rate rises this year and now we maybe will get one.  Yet the same establishment moves like the “Slippery People” sung about by Talking Heads onto fiscal policy and claims that will work.

The problem here is that quite a few countries have been seeing expansionary fiscal policy. Japan for example had an attempt at reining it back with the 2014 consumption tax rise but now adds ever more and the UK is a lower scale example but similar in principle. Germany has taken the other path and managed to apply it to some of the weaker Euro area economies but deficits have continued. So we are told stimulus is a good idea but we get no explanation of why it has not worked so far.

Meanwhile we get the occasional flicker from the bond vigilantes as bond yields rise but lets face it even 1.27% for a ten-year UK Gilt is historically very cheap and compared to inflation prospects may well be not far off insane.


The UK looks on course for a fiscal policy reset and boost

The last few months have seen more and more bodies come out in favour of easier fiscal policy or a fiscal stimulus. For some such as the International Monetary Fund or IMF this has been something of a U-Turn as it had of course previously imposed austerity on several nations in the Euro area particularly Greece. For others it has been a policy shift from telling us that easier monetary policy would work as they decided that people would figure out that  8 years of ever easier monetary policy meant by definition that it had not. Some of course were always in favour and will be pleased to note the economic mood music joining them. There have been signs that UK economic policy was moving that way to and we have leaned some morning this morning already as UK economic announcements become subject to the political conference timetable. However some care is needed as of course the UK has run a series of fiscal deficits and the talk of a fiscal surplus was just that. I have pointed out many times that the former Chancellor George Osborne seemed to be 3/4 years away from a surplus at whatever point in time one might choose. Although there was apparently at least one person who believed them if this from Robert Peston is any guide.

Amazing that borrowing rules torn up & we don’t have new ones. Think what City would say if this happened on Labour’s watch

What has changed for the UK?

There has been a change of Chancellor as George Osborne was removed and replaced with Phillip Hammond and it looks as though the new government will be fiscally looser. However there was also a major change in an element of the UK public finances as bond yields or what are called Gilt yields fell heavily making it much cheaper for the UK to finance a fiscal deficit. This meant that the much vaunted “bond vigilantes” have had all the success of General Custer at Little Big Horn.

It  seems like another world now to look back and see that the UK entered 2016 with a 10 year Gilt yield of around 2%. We saw international yields plunge helped by ECB and Bank of Japan policy and the song was clearly this from Alicia Keys.

Oh, baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’

Depending on which date you choose this took us to around 1.3% and then post the EU Leave vote Gilt yields fell even faster and price rose. This was a more domestic move and to some extent this time around the UK helped pull international yields lower. The Bank of England was expected to add to its existing £375 billion portfolio of UK Gilts and duly announced another £60 billion as well as Open Mouth Operations saying that more would be done if it considered it necessary. Thus the 10 year Gilt yield fell and is 0.74% as I type this as the Bank of England purchases an extra £3.51 billion of UK Gilts each week.

If we now switch to the yield which really matters for fiscal policy we see the impact of this. If we borrowed for 30 years right now as I type this the Gilt yield is 1.46%. That is extraordinarily low for the UK and as a comparison over my career ( also 30 years or so) I have seen it as high as 15%. This means that more projects should be viable due to the lower cost of financing the project.

What has the Chancellor actually said?

The Guardian has been hot in the case and reports this claimed early wire on his speech later on.

The Conservatives were elected “on a promise to restore fiscal discipline”, Hammond is to note, adding: “And that is exactly what we are going to do. But we will do it in a pragmatic way that reflects the new circumstances we face.”………“But when times change, we must change with them. So we will no longer target a surplus at the end of this parliament.”

That seems to open the door for an easing of policy which would be consistent with the hints we have had so far. Speculation is of an easing of the order of a bit more than 1% of economic output of GDP but of course that is speculation for now. We did however get one specific plan.

Hammond will also unveil a £3bn package to speed up homebuilding, including using surplus public land and brownfield sites, encouraging smaller builders and innovations such as prefabricated modular homes…….Of the £3bn total, a third will be used as short-term loan funding for smaller housebuilders and what are described as “custom builders and innovators”, intended to create an extra 25,500 homes before 2020.

An extra 25,500 homes does not sound much does it? Also there is something very familiar at play here for announcements about extra UK housing which is that some of it has been announced in the past! So only around a third is actually new here. Perhaps we should be grateful that announcements of more have in reality meant less as has happened at the Ebbsfleet project.

They should get in the person I watched for a while on Saturday evening dismantling one of the cranes by Battersea Power Station! Quite a work ethic and very brave too.

The BBC has gone further.

“As we go into a period where inevitably there will be more uncertainty in the economy, we need the space to be able to support the economy through that period,” he said. “If we don’t do something, if we don’t intervene to counteract that effect, in time it would have an impact on jobs and growth.”

As ever it is the two i’s of infrastructure and investment which lead the rhetoric.

“I do think there is a case that we should look at very carefully for targeted, high-value investment in our economic infrastructure”


There is a fair bit to consider here. The fiscal policy of the UK is on its way to a reset and is doing so from a position of an existing deficit as shown below. From the Office for National Statistics.

In the financial year ending March 2016 (April 2015 to March 2016), the public sector borrowed £76.5 billion. This was £18.9 billion lower than in the previous financial year and less than half of that in the financial year ending March 2010 (both in terms of £ billion and percentage of GDP).

So austerity was a reduction in the overall deficit over time rather than a real push to a surplus. In the meantime circumstances have changed because the UK can borrow at around 1.5% for the longer-term rather than the 5% or so expected back in the day by the Office for Budget Responsibility.

Can we rise to the challenge or will it be another example of what is called “pork-barrel” spending? I am sure you can all think of examples of both. If we just look at travel infrastructure there are clear cases yet sadly we seem ever more wedded to the expensive HS2 project which will not actually carry that many people. As Battersea Power Station is on my mind perhaps Pink Floyd could have another go but this time replacing the pink elephant with a white one. An HS3 style plan for northern cities seems much wiser to me. Although of course there are capital style risks for the future in letting the national debt rise and rise as well as dangers for inflation with money supply growth also strong as I pointed out on Thursday..

Meanwhile UK manufacturing appears to be doing rather well if this morning’s Markit PMI survey is any guide but of course that is so far…..

Number Crunching

There are regular reports that we can borrow at negative levels via index-linked Gilts which may lead some to conclude that this is the way to go. However some of this is another Ivory Tower misunderstanding. Yes there are elements that look cheap here but unlike conventional Gilts there is a variable which needs to be assumed which is inflation and in particular inflation as defined by the Retail Price Index. An inflationary episode would lead our new experts to be declaring yet another “surprise” which of course “could not possibly have been expected”



Ever lower government bond yields are not “free money”

In terms of interest-rates there have been several phases in the credit crunch era. First we saw large reductions in official interest-rates which were badged as temporary and emergency but of course now look ever more permanent. Then we had various ” extraordinary monetary measures” such as QE to reduce longer-term interest-rates and bond yields. Some years later we saw a new phase of interest-rate reductions as an increasing number of nations took their official interest-rates into negative territory. This was often accompanied by yet more QE with my own country joining the new QE wave only last month. As I pointed out from the early days this has looked much more like a type of junkie culture than any cure unless of course someone can think of a cure that takes 8 years or so not to work. After all if it was working why are we where we are? The one country which is trying to buck the trend has managed only one interest-rate increase so far and keeps mentioning negative interest-rates.

Fiscal Policy

There has been an extraordinary boost here provided by the fall in sovereign bond yields and this has been highlighted by Fitch.

Cash flow benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped in response to central bank monetary stimulus.

We are left wondering if this was the plan all along! Treasuries around the world will no doubt have been keen to rubber stamp QE plans by central bankers which will reduce their borrowing costs. What price independence anyone?

We also get an idea of the boost provided.

Relative to yields available in 2011, global investors are foregoing over $500 billion in annual income on $38 trillion in currently outstanding bonds as a result of the collapse in sovereign yields.

A US $500 billion a year gain to government’s is nothing to be sniffed at and provides a backdrop to the current cries for more fiscal stimulus. It has been produced as a result of this.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

Some countries have benefited more than others.

The largest declines in weighted-average sovereign yields among the top issuers over the past five years have been seen in Spain (down 422 bps) and Italy (down 413 bps). Both countries faced elevated spreads during 2011, when investor concerns surrounding Eurozone risk were peaking.

That is interesting as their economic performance proves that this is no panacea on its own. Spain has seen an economic recovery whilst Italy continues to struggle and currently they could not look much more different. There is something of a contradiction here as Italy benefits more from the change ( US $79 billion per year) than Spain ( US $45 billion per year).

For other countries the Financial Times offers us these estimates.

Japan has saved more than $95bn a year as a result of the decline in rates, while the US, UK and Germany collectively pay $104bn less annually, the study estimates.

Also some countries now get paid to borrow.

Stimulus from the European Central Bank and Bank of Japan has unleashed a rally across fixed income markets, with nearly $13.2tn of debt trading with a yield below zero at the end of last week. Japan, France, Germany and Switzerland are now paid to issue short-dated sovereign bonds.

It is not just short-dated bonds as ten-year yields in Japan,Germany and Switzerland are negative as well. Being paid to borrow is a credit crunch phenomenon which impacts on the number below which must have Bond Vigilante’s in floods of tears.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

The UK

Let me bring a couple of things together which is that whilst it heads in another direction Fitch does seem to understand the correct methodology.

Fitch notes that the effects materialise as higher coupon bonds mature and are refinanced with low or negative yields.

If we look at the UK we see that conventional issuance will be of the order of £100 billlion this year which with yields some 1.8% lower than in 2011 is an annual bonus of £1.8 billion. Actually against OBR forecasts it is a lot better because it was assuming more like 5% for Gilt yields so the annual gain is currently of the order of £4.3 billion.

Also Fitch skirts around something else which is that central banks invariably return the coupons and yield from their QE purchases to the home treasury. Here is the latest data on the Bank of England.

In July 2016, there was £1.1 billion transferred from the BEAPFF to HM Treasury, bringing the total money transferred to HM Treasury under the APF scheme to £5.0 billion in this financial year-to-date (April to July 2016).

The Bank of England entrepreneurial income for the financial year ending March 2016 (April 2015 to March 2016) was calculated as £11.9 billion.

Not all of it is counted in the public finances believe it or not but we know that as the Bank of England expands its conventional QE operations by another £60 billion the benefit to HM Treasury will rise.

It is really quite clear why politicians steer clear of this sort of thing as people may wonder why the public finances do not look a lot better……?

Even the losers get lucky some times

Tom Petty is right here because whilst Fitch is in effect whining on behalf of income investors some have pocketed a lot of cash.

Given the significant downward moves in interest rates over the past five years, many investors have already seen large gains in their bond portfolios.

There have been extraordinary gains so where have they gone? Who now has all this wealth? i think we should be told don’t you? Also someone should tell Fitch that the sentence below makes things worse and not better.

In addition, central banks’ holdings of sovereign securities have grown sharply, mitigating the prospective impact of ultra-low rates on private investors.

Future investors and savers are hit

We are back to this issue.

Still, for many “buy and hold” income-oriented investors, the roll-off of maturing securities requires that new cash be invested at much lower coupon rates. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.

That is a polite way of explaining how many of the business models for longer-term saving such as defined benefit pensions have been blown up by the policies Andy Haldane of the Bank of England is so keen on. Not his pension though as the UK taxpayer backs it.


If we take a broad brush approach to the falls in sovereign bond yields we see that there have been two main gainers. Firstly existing holders of government bonds and secondly governments which pay less for new borrowing and receive transfers from the operations of their central banks. Quite a wealth shift in the first instance and an income shift in the second. This has the implication that monetary policy has strong fiscal effects which blows up the independence bubble that central bankers and their acolytes keep trying to maintain.

But there is a price and it is in the process of being paid by people and companies who reply in income both now and in the future. It has become a lot more expensive if you try to purchase it and in other variants is either very low or zero. So future income has been taken from them and they represent not only pensioners and savers both now and in the future but companies with pension plans.

Oh and who has all the new wealth? What economic benefits has it brought?