Secular Stagnation Part III – The Expectations Fairy

“So what’s going on here? Well, it might sound like a hokey religion, but central banking is really a Jedi mind trick. Just saying something can be enough to make it happen. That’s because the power of the printing press gives their words a distinct power. Well, that and the fact that the economy is already one big self-fulfilling prophecy.” – Matt O’brien,  “Abenomics has only worked because foreigners think it willContinue reading

What Is The Risk The Euro Crisis Will Reignite?

The euro zone crisis is not back — at least not yet.

Recent movements in global markets following concerns about Portugal’s Banco Espirito Santo really had as much to do with market nerves after a long spell of repressed volatility as it did with the state of the bank’s balance sheet. Despite the current calm, everyone knows that volatility will return one day, and no one wants to be caught on the back foot when it does arrive. So the initial response is to hit the “sell” button and then ask questions.

Beyond this context, there is a lack of certainty in the market about which way bond yields for the so-called “peripheral” euro zone countries are heading in the near term — and what exactly the risks associated with holding them really are. Riding the yield compression, in the case of the Portuguese 10-year bond from over 7 percent to under 3.5 percent was a one-way-bet no-brainer once the impact of Draghi’s July 2012 speech became crystal clear. Continue reading

The Italian Runaway Train

There has been lot’s of debate in the press and in academic circles over the last week or so about whether Italy’s latest contraction constitutes a triple dip recession or simply a continuation of what’s been going on over many many years. This is an interesting theoretical nicety, but in fact what is happening in Italy at the moment goes a lot further than problems faced by a recession dating committee. The real issue that arises in the context of the Euro Area at the moment is a far more specific one. Will the ECB do QE? And if it does when will it push the button? And what could happen if it doesn’t. Perhaps a case study of the Italian case is worth the effort here. What is likely to happen to Italian debt if there is no ECB intervention soon? Let’s take a look at the dynamics. Continue reading

Multipliers and adding up

Bank for International Settlements 84th Annual Report, page 11 –

Second, as growing evidence suggests, balance sheet recessions are less responsive to traditional demand management measures (Chapter V). One reason is that banks need to repair their balance sheets. As long as asset quality is poor and capital meagre, banks will tend to restrict overall credit supply and, more importantly, misallocate it. As they lick their wounds, they will naturally retrench. But they will keep on lending to derelict borrowers (to avoid recognising losses) while cutting back on credit or making it dearer for those in better shape. A second, even more important, reason is that overly indebted agents will wish to pay down debt and save more. Give them an additional unit of income, as fiscal policy would do, and they will save it, not spend it. Encourage them to borrow more by reducing interest rates, as monetary policy would do, and they will refuse to oblige.

Note the contradictory logic of the two reasons. The first says that banks will only lend to bad borrowers and willing good borrowers can’t get credit. The second says people getting extra income from fiscal or monetary stimulus will only use it to  pay down debt, reducing demand. But what about those good borrowers who can’t get credit due to the first reason? And what about those people who are paying down debt, thus helping banks get into better shape and thus, er, lend?

What starts out as an argument for weak multipliers doesn’t add up, and it’s not made any easier to follow by the apparent decision not to directly address their main critic on this point, Paul Krugman.

Olli Rehn: a tribute

Olli Rehn’s last ECOFIN press conference has just finished. AFOE would like to take this momentous occasion as an opportunity to salute Rehn’s towering achievements, and Matthew Yglesias passes on exactly what we need.

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Yes, we know he was Enlargement Commissioner. But seriously folks, Rehn took office as Commissioner for EMU on the 9th of February 2010. If you were to overlay those two charts, the lines would diverge essentially right then.

And, desperately, he thinks he’s done a brilliant job:

It’s only topped by the astonishing fact that some Iraq War advocates not only continue to claim that Iraq had weapons of mass destruction, but claim that the weapons are still present to this day.

Will Japan Re-enter Deflation in April 2015?

Reading the most recent statements from Bank of Japan Governor Haruhiko Kuroda or Finance Minister Taro Aso you would get the impression that the days of deflation are now well and truly numbered in Japan. Martin Schulz, economist at Fujitsu Research Institute in Tokyo, goes even further. “Deflation is over in Japan,” he told Bloomberg Television First Up’s Angie Lau . Even Japan’s industrial leaders now believe inflation is here to stay: the country’s inflation rate will be 1.5 percent in the spring of 2015, and 1.7 percent in 2017, according to average forecasts in a Bank of Japan survey conducted in March this year. Continue reading

Secular Stagnation Part II – On Bubble Business Bound

“I now suspect that the kind of moderate economic policy regime…… that by and large lets markets work, but in which the government is ready both to rein in excesses and fight slumps – is inherently unstable.”
Paul Krugman – The Instability of Moderation

“Conventional macreconomic theory leaves us in a very serious problem, because we all seem to agree that whereas you can keep the federal funds rate at a low level forever it’s much harder to do extraordinary measures that go beyond that forever. But the underlying problem may be there forever. It’s much more difficult to say, well we only needed deficits during the short period of the crisis if equilibrium interest rates can’t be achieved given the prevailing rate of inflation.”
Continue reading