ECB Interest Rate Policy

Brad Setser has a post today on Kate Moss, not provoked by her evidently economically intriguing modelling properties, but due to the Kate-Moss-thin credit-spreads which Bloomberg’s William Pesek refers to in this article. What really turns Pesek on it turns out isn’t Kate Moss at all but the possible existence of links between China’s economic boom and the recent surge in popularity for credit derivatives.

And it is in the context of this evolutionary chain that Brad Setser’s work on China and Systematic Risk offers itself as some kind of missing link.

But as I continued reading Brad’s post, and even more so Pesek’s argument that current global growth “comes against the backdrop of a readiness by China — and other Asian central banks — to keep its currency from rising and the U.S. dollar from falling. It has put a floor under the dollar and a ceiling above U.S. debt yields.”, I couldn’t help but forget Kate Moss and move onwards and upwards to the issue of the current interest rate policy debates revolving around the ECB.

Essentially I think there’s a topic here which isn’t getting the discussion it deserves. The US Federal Reserve is currently taking responsibility for attacking some of the global imbalances which everyone is talking about. It is doing this by starting to target house prices in the US. On this topic see this post from Stephen Roach, and this speech from Alan Greenspan, in particular this:

…it is difficult to dismiss the conclusion that a significant amount of consumption is driven by capital gains on some combination of both stocks and residences, with the latter being financed predominantly by home equity extraction. If so, leaving aside the effect of equity prices on consumption, should mortgage interest rates rise or home affordability be further stretched, home turnover and mortgage refinancing cash-outs would decline as would equity extraction and, presumably, consumption expenditure growth. The personal saving rate, accordingly, would rise.

Carrying the hypothesis further, imports of consumer goods would surely decline as would those imported intermediate products that support them. And one would assume that the U.S. trade and current account deficits would shrink as well, all else being equal. How significant and disruptive such adjustments turn out to be is an open question.

Ergo, squeezing mortgage rates squeezes consumption which ultimately hits imports and reduces the US trade and current account deficit. This is thus the path on which Greenspan has embarked.

There is a problem though….. if the Fed continues the interest raising process, but the ECB stays put, the dollar will continue its gentle rise driven by the yield differential, and this will offset what Greenspan and Co are trying to do with the US CA deficit.

So….. my guess is that at the ECB they are already coming under significant pressure to raise in the not to distant future simply to support the Fed initiative (which I am sure Trichet would be the first to accept is in everyone’s interest). This pressure was, I feel, evident in the emphatic statements coming from Trichet after the last ECB meeting, statements which are, perhaps hard to comprehend if you don’t look at the complete picture.

But of course, raising eurozone rates will be controversial politically, since in the case of Germany (and almost certainly Italy) it is hardly indicated.

Bloomberg this morning draws attention to the great lengths to which the EU finance ministers went yesterday to stress that they didn’t think inflation was a great looming problem in the eurozone. This can only be read as directed at the ECB.

Reporting on the meeting Austrian Finance Minister Karl-Heinz Grasser stressed that he didn’t ” see any inflationary pressure..Interest-rate moves are not necessary, at least this year.”

Economics Commissioner Joaquim Almunia basically backed them up: “There continues to be no evidence of second-round effects stemming from higher wage growth, but there is no room for complacency,”

I imagine they really loved this over at the ECB and, of course, across the pond at the FED.

Basically what I am arguing here – for reasons which flow essentially from the great Kate Moss debate – is that either the Fed stops, or the ECB has to raise. Globally, if you take the rebalancing arguments seriously the first can’t happen, so the second – at some stage – has to. But just watch out for the fall-out.

This entry was posted in A Fistful Of Euros, Economics: Currencies and tagged , , , , , , , , , , , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

27 thoughts on “ECB Interest Rate Policy

  1. If the Fed raises and the ECB doesn’t, sure, it’s likely to cause the dollar to rise (or at least stop declining) versus the euro. Which will tend to worsen the US trade imbalance with the Eurozone (subject to the short-term action of Mr. J-Curve, of course).

    But, last time I looked, only about a quarter of the US trade deficit was the result of trade with the Eurozone.

    So, maybe tGreenspan is hoping that the import-deadening effect of decreased consumption will offset a stronger currency WRT the Euro. After all, we know the dollar isn’t getting any stronger WRT the renminbi.

    Doug M.

  2. “But, last time I looked, only about a quarter of the US trade deficit was the result of trade with the Eurozone.”

    “After all, we know the dollar isn’t getting any stronger WRT the renminbi.”

    Yep (on the EU trade factor), but no on the renminbi. This is no longer guaranteed due to the *float*. Remember that the renminbi is now pegged to a *basket* of currencies, so the euro weighting will tend to draw it downwards. Also the Yen has been steadily dropping against the dollar.

    There is also the inverting yield curve issue to consider. There isn’t much the Fed can do about this, but clearly having ECB rates at 2% and the 10 year German bund at a little over 3% makes it difficult for 10 year US treasuries to climb too far.

    The key impact of the euro isn’t in the reserve currency area but in the size and depth of eurozone financial markets, particularly the bond markets. In an epoch of globalised capital markets it’s hard for the US to detach too much from the eurozone.

  3. Also don’t forget Doug that the CA deficit can be corrected in two ways:

    a) By reducing imports
    b) By increasing exports

    In the second case the US must look to Europe as a market where it can sell. Hence the Euro/USD is also an important metric.

    Bilateral trade balances aren’t so much what matters as the global sum game.

  4. Funny, I thought arbitrage theory said that if interest rate of USD is higher than EUR, then USD value en EUR will fall: let’s say initial EUR/USD exchange rate is 1.0, USD rate is 4%, EUR rate is 2%, after one year you have 1.04 USD from 1 USD and 1.02 EUR from 1 EUR without taking any risk in either strategy, so 1 USD should be worth 1.02/1.04 ~= 0.98 EUR.

    Of course this effect is dwarfed by exchange rate volatility and other factors but still… Any serious macro study on this?

    Laurent

  5. Laurent:

    If the real interest rate of currency A is greater than that of currency B, then currency A should strengthen against B, because investors sell B to buy A in order to invest at the higher interest rate that A offers.

  6. “If the real interest rate of currency A is greater than that of currency B, then currency A should strengthen against B, because investors sell B to buy A in order to invest at the higher interest rate that A offers.”

    Yes, and this is what has been happening over the last month or two, with the euro edging slowly down. Every time Greenspan raises an extra quarter point this process gets another push.

    “I thought arbitrage theory said that if interest rate of USD is higher than EUR, then USD value en EUR will fall”

    Maybe you are thinking of the effects of all this on price levels. The higher rates in the US will be mildly disinflationary, while the relatively lower ones in the eurozone will be mildly inflationary on the margin. So the relative PPPs can change slightly, but only slightly. Basically I am not convinced that – ex petroleum – inflation is a big issue here.

    We keep getting promises, promises that it has to be coming, but its still a case of long time no see.

  7. Laurent:

    The extract below from Bloomberg this morning is the standard view. What I’m saying on top of this is that the ECB may get dragged in to try and help stem the rise of the dollar (at the price of accepting slighly lower growth in the eurozone).

    The dollar gained against the euro for the fourth day in Asia on speculation investors will buy U.S. debt because of a widening yield advantage over Europe and Japan.

    The U.S. currency reached a one-week high after minutes of last month’s Federal Reserve meeting released yesterday showed policy makers’ concern about inflation grew after Hurricane Katrina ravaged the Gulf Coast. “Further rate increases probably would be required,” the Federal Open Market Committee said, boosting the yield premium of Treasuries.

    “The Fed’s rationale is to control inflation,” said Simon Stevenson, who helps manage about $4.6 billion of funds at Merrill Lynch Investment Management in Sydney. “I can understand their nervousness, and the dollar looks strong for the time being, buoyed by higher interest rates.”

    Mervyn King over at the BoE also seems to be on board. This morning’s FT:

    Mervyn King on Tuesday night signalled he was not convinced of the case for lower interest rates and could see many reasons why the rise in oil prices might increase inflationary pressure….He insisted …. high oil prices must lead to slower growth of household incomes; implied the recorded low growth rate might understate economic conditions and prospects; and reminded his audience that high oil prices reduced the economy’s ability to grow without inflation.

    Citing the recent words of Don Kohn, one of the US Federal Reserve governors, he said: “Policymakers should be cautious about responding aggressively to estimated movements in economic slack.”

  8. Edward, thanks for the quotes. If the dollar goes indeed up that would be real bad news for the other side of the pond.

    BTW, why is ECB taking into account raising oil prices? This is all external inflation, euro economy will handle it by reallocating ressources to less oil dependant ways of doing things so it seems to me more “good” and temporary inflation that “bad” internal inflation where rates is an useful tool.

    Rising euro rates will not lower oil prices as such (may be through lessening dollar appreciation, but if dollar goes up the dollar risk goes up too – look at US debt). May be it will even push them higher in the mid term since the necessary R&D investment to lessen oil dependancy might not be done because of higher cost of capital because of higher interest rates…

    More questions :).

    Laurent

  9. This isn´t going to work out as advertised. First of all, it would be much easier for China to initiate the rebalancing than it will be for the U.S. Stiglitz has proposed that China introduce an export tax (which should more appropriately have been labeled a removal of privileges for exporters). We tend to be all over Bush and the EU whenever the subject of agricultural subsidies comes up, but apparently there is nothing more important in the world than to reduce the funds available to the American consumer just so the Chinese continue to underprice their manufacturing exports, undersupply their domestic demand, destroy their environment and ignore the need for institutitional change (intellectual property rights [hard to do in a short timeframe], bank consolidation [definitely easier] etc.)

    Warren Buffett proposed a scheme last year that not one single economist appears to have followed up on – an ingenious use of derivatives that looks like it could actually produce the desired effect. The conventional path that economists appear to be preferring is just another instance of the time-honoured rat-race logic that is so deeply embedded in most of economic theory. (Admittedly even Buffett employed it in his “Forbes” article, although it isn´t in any way conducive to his concept.)

    Why should Greenspan not continue and Trichet not start to hike rates?
    1) The U.S. housing market is already beginning to cool somewhat. The bubble is mostly concentrated in California and Washington D.C. Housing starts are only half of what they were at their peak in the 70s.
    2) High interest rates may induce savings, but ultimately these savings will, of course, entice their owners to look for things to buy. Ceteris paribus, American consumers would in a few years be in a position to spend even more on Chinese (or maybe Indian) imports – not just “money they don´t have”, but accrued interest in their accounts.
    3) Savings doesn´t translate into investment in export industries – only foreign demand does. China insists on FDI and technology transfer, thus strictly limiting import demand growth.
    Savings doesn´t automatically translate into investments in import substitution industries either. It could just as well be used towards increasing the efficiency of existing production and subsequently eliminating the working-hour differential between the U.S. and Europe. The degree to which imports would be substituted is essentially a matter of demand elasticities relative to prices and income. When income is highly leveraged – as American consumers´ income certainly is -, then that rubber band may not stretch far enough to fit around both the consumer and their shopping basket. Price inflation might prove detrimental to real demand expansion. Compensating for the supply shock could thus even create a need for higher deficit spending than would be mandated otherwise. Of course, there is always the option to check how the 10%-unemployment suit looks on the American economy.
    “Global rebalancing” is a misnomer. Instead of rebalancing the global distribution of actual wealth, the envisaged course of action will achieve the opposite. When the asymmetries will finally have expanded further, there will be a strong temptation to turn towards a political solution. That option, however, will only be open to the Chinese, who might then do a Smoot-Hawley on the West. Better to tell them right now that they shouldn´t favour us so much. When a swimmer appears to be drowning somewhere on the Atlantic coast in Florida, nobody would think of alarming rescue teams in California. Why should monetary policy follow such a recipe for failure?

    BTW, people who believe that interest rate differentials are the sole driver of currency fluctuations shouldn´t even dream about putting money into the currency markets for anything but long periods of time.

  10. A further point regarding the credit derivative markets: The increase in the use of interest rate derivatives is totally dependent on interest rate volatility. If central banks were to credibly commit to a five-year moratorium on interest rate changes, these markets would dry up. I certainly don´t claim that such a moratorium could be engineered easily. However, introducing interest rate volatility with a view to solving problems that interest rate policy cannot solve adds additional risk rather than mitigating it. Citing a heightened level of exposure as a reason for stepping up another rung of the ladder looks like a pretty desperate strategy.
    Barry Ritholtz facetiously announced a while back that the Fed´s interest-rate responsibilities had been outsourced to the PBOC. The newest idea seems to be to have the Fed do the Chinese treasury´s job and even call upon the ECB to lend its support.

  11. (at the price of accepting slighly lower growth in the eurozone)

    Can’t get all that much lower in the eurozone’s largest economy and still be called growth…

  12. “The newest idea seems to be to have the Fed do the Chinese treasury´s job and even call upon the ECB to lend its support.”

    Well yes, to a certain extent this is what is happening. Realistically Chinese policy isn’t going to be set in Washington or New York, so the US has to take the action it deems best for itself, to try and correct the CA deficit (it could of course also do something about the fiscal one but that is another country as they say) and to try and raise the domestic savings rate. This is what Greenspan is working on now.

    I don’t know really how far he should go, since for the reasons Kotlikoff and others indicate (and as Brad Setser regularly points out Dooley & Co argue in another setting) this ‘imbalance’ may have no easy solution. There is a limit to how far you can put the world aright simply by squeezing the US consumer.

    To be clear: I am not arguing that the ECB *should* raise rates, I think that would be a big mistake. I am trying to explain why Trichet, Mervyn King and other central bankers tend to be in favour of moving in that direction.

    “BTW, people who believe that interest rate differentials are the sole driver of currency fluctuations….”

    I’m not sure where this is directed, but it wouldn’t be my view. Interest rate yield differentials are one factor, but only one. Growth would be another, but again at the moment this favours the US too. Self-fulfilling prophecies are of course another factor: ie if people believe the dollar is going to rise then people may buy and that may in fact push it up.

    Laurent:

    “why is ECB taking into account raising oil prices?”

    Well this is what the references to secondary effects are all about. Everyone accepts that oil prices are volatile and can go up and down, but what people worry about is that these increases are passed through via increased prices in industries which depend on energy (utilities, transport, manufacturing etc) and of course that these then filter through again into wages. As I am saying, so far there is little evidence of that, with core inflation (without food and energy) remaining remarkably tame. This however doesn’t stop people arguing that higher levels of inflation are just round the corner (seemingly eternally so) and the raise in interest rates is proposed to reduce aggregate demand and take pressure off prices. As I said I am in no way in favour of raising rates at the ECB right now, only a couple of months ago we were talking about lowering them, and eurozone conditions haven’t – bar a few optimistic indicator readings – really changed that much in the meantime.

  13. Laurent

    To give you an idea. You will see I cite Mervyn King above about the dangers of rising inflationary pressure. Well what I paste below is data on employment and earnings in this morning from NTC research. It shows unemployment up and earnings steady (not drifting upwards above trend). So there should be no cause for alarm, and some reason for *reducing* rates slightly to combat the slowdown. Some members of the BoE monetary policy committee favour cutting the rate, but not Mervyn King, I think I am offering part of the explanation for this:

    The number of people out of work and seeking benefits in the UK rose for the eighth consecutive month in September, according to the Office for National Statistics (ONS) today. The claimant count rose by 8,200, while August’s rise was upwardly revised to 2,700.The claimant count has now risen for the longest period since the economic slump of the early 1990s. Meanwhile, annual average earnings growth held steady at 4.2 percent in the three months to August, signalling that higher inflation is still not feeding through to wages.

  14. Maybe somebody can explain this to a non-economist. If the US Federal Reserve Bank raises interest rates to a level detrimental to Chinese exports, what would prevent the Chinese Central Bank from using its foreign reserves in dollars to lower market interest rates by offering cheap credit in dollars?
    I can see how a central bank can always force lower interest rates, but why would it always be able to raise them again?

  15. Central bank lends out/controles more shortterm money than the rest of the market. And there is more shortterm money lend out every month than longterm

  16. You’re right that the Fed seems to be targeting house prices but the issue is whether it has the instruments. We’ve seen for years now that the long rate and the policy rate often move in opposite directions. Although the 10 year yield has been moving up in the last few weeks — as signs of actual inflation emerge. It’s much easier for the Fed to move the entire yield curve — and thus tackle the housing bubble — when the market is dealing with fears about higher inflation at the same time.

  17. “If the Fed raises and the ECB doesn’t, sure, it’s likely to cause the dollar to rise (or at least stop declining) versus the euro. Which will tend to worsen the US trade imbalance with the Eurozone (subject to the short-term action of Mr. J-Curve, of course).” – Doug M

    Second this.

    As for Kate Moss’s assets … last pic I saw didn’t actually inspire investor confidence!

    🙂

  18. “If the US Federal Reserve Bank raises interest rates to a level detrimental to Chinese exports, what would prevent the Chinese Central Bank from using its foreign reserves in dollars to lower market interest rates by offering cheap credit in dollars?”

    Firstly they don’t have enough dollars to sustain this kind of activity alone (buying US treasuries effectively has this impact, at least on 10 year rates, but it isn’t simply China which is doing this, read Brad Setser), secondly they are not in head-on conflict with the Fed, the two are at one and the same time collaborating and experiencing friction: think game theory I suppose. They buy the quantity of Treasuries they feel they need to hold, but not sufficient to bring down even more criticism. Much of the buying of US debt instruments is coming via Europe.

    @ P O’Neill

    “You’re right that the Fed seems to be targeting house prices but the issue is whether it has the instruments.”

    I agree. One of the problems which Greenspan faces is a possible inversion in the yield curve (in layman’s terms this means that the buying of US treasuries is so strong that the effective interest rate they carry becomes lower than the ‘overnight rate’ set by the Fed Open Market Committee). This is why I think they are keen to see others raise rates. There is a bankers and a politicians view on this.

    Interestingly Brad Setser linked to this Jim Cramer article on George Bush:

    http://www.newyorkmetro.com/nymetro/news/bizfinance/columns/bottomline/14639/

    http://www.rgemonitor.com/blog/setser/104313

    My gut feeling is that depite all the talk of ‘transparency’ and ‘learning curves’ behind closed doors there is a Central Bank view that something has to be done (which doesn’t mean that something can be done: if you look at the piece I link to by Kotlikoff on the US and China, it is clear that there may be strong demographic reasons why the imbalance may continue for some time to come. The difficulty is that the US might get ‘hollowed out’ – just like Spain might – while this process continues). So my guess is that back in Washington the other weekend, apart from Fazio, they were discussing ‘global imbalances’ and Europe and Japan taking more of the weight, and this will mean in monetary policy terms too.

    If you notice Fukui is being pretty pro-active right now too:

    http://www.bloomberg.com/apps/news?pid=10000101&sid=aDJ.tUKANdbo&refer=japan

    Japan’s bonds fell and 10-year yields approached their highest since November after central bank Governor Toshihiko Fukui said interest rates will rise from zero percent because of inflation. Japan’s seven years of falling consumer prices are close to ending, which means rates “will eventually head toward positive territory,”

    So what I am saying is that there is a consensus that the US can’t raise rates alone, and to sell this idea to the politicians and the general public you need the ‘inflation threat’ story, even if – at least ex-US, Spain and Greece – there is relatively little hard data to back up the story.

    Even in the US, of course, with the dollar drifting steadily up, and in the wake of Katrina, it’s hard to believe that in the foreseeable future core inflation is going to be in real danger territory.

    One thing people tend to forget is that an oil price hike constitutes what economists call a ‘level effect’. That is there is a one-off effect on the level of prices. But if after the hike the price holds – at say around 60 dollars a barrell – and there are few ‘secondary effects’ then after 12 months this moves out of the year-on-year cpi. So the hike affects the price level on a one-off basis, but not the *rate* of growth of inflation.

    So, if this is the case, the main effect of $60 oil is on growth not on inflation, which means….. well it doesn’t mean you need a general raising of interest rates.

    So this then brings us back to housing in the US and Spain, and how Mervyn King with 4.75% rates in the UK burst (hopefully in a benign way, but we still don’t know) the bubble.

  19. The difficulty is that the US might get ‘hollowed out’ – just like Spain might – while this process continues

    OK, next stupid question. What prevents US legislators upon hearing this to decide to use a popular way to reign in the imbalance, in other words, a tarif?

    And, if US demand slackens, why would it affect Chinese exports more than European exports?

  20. “What prevents US legislators upon hearing this to decide to use a popular way to reign in the imbalance, in other words, a tarif?”

    Oh, I think there are plenty of them who would like to do this. But there are plenty of others who realise that this might not be such a good idea. (Before I go on, I should indicate that not everyone is worried about the ‘hollowing out’ danger: I however would be, in terms of having skills and capacities – ie human capital assetts – confined in restriced areas of things like services and housing).

    The thing is the US and China are the two ‘good news stories’ about the global economy at the moment (plus maybe India and Turkey). The US is in a boom, not a recession, and so is China. So the legislators might win votes with those in the industrial sector who might be most negatively affected by the China impact, but massively lose them among others groups who would find themselves with a lower standard of living as a consequence of such protectionism.

    Also no-one who understands sufficient economics really wants to do anything to reduce the levels of world trade, the emphasis is currently in the other direction: how much agricultural subsidy is the EU and the US willing to cut to get a Doha deal.

    So one strong school of thought thinks the US should just learn to live with the CA deficit. Greenspan doesn’t seem to be one of these people.

    “And, if US demand slackens, why would it affect Chinese exports more than European exports?”

    Oh no, it will hit Europe, Japan, everyone who relies on exports to the US. This is why I am saying this will not be welcome news in Germany: politically or economically. We are being asked to ‘share the burden’ of the correction.

    I mean you saw your inflation rates (Germany) yesterday didn’t you? Ex heating oil and motor fuel you are at 1.6% y-o-y. So where exactly is the fire that needs putting out?

  21. BTW The French CPI for August has just come out. The y-o-y French CPI is 2.2%. The EU oriented Harmonised CPI is at 2.4%, but the important excluding energy index is at a meagre 1.1%. If there were any secondary effects you would expect to find them here. So again, where is the fire?

    http://www.insee.fr/en/indicateur/indic_conj/indconj_frame.asp?ind_id=29

    And for good measure, here’s Sweden:

    In September the underlying inflation as an annual rate by UND1X was 1.0 % (1.0 % in August). The Harmonised Index (HICP) increased with 0.9 % from August to September and increased by 1.1 % since September 2004. The Net Price Index (NPI) increased with 0.7 % from August to September and with 0.1 % since September 2004.

    http://www.scb.se/templates/pressinfo____147752.asp

  22. OK, next stupid question. What prevents US legislators upon hearing this to decide to use a popular way to reign in the imbalance, in other words, a tarif?

    To give the feel of things from the west side of the pond, back in the summer there was a free trade deal made between the US and the Central American naitons (DR-CAFTA), and since the vote on it was very close, many legislators whose opinions wouldn’t ordinarily be national news were quoted here and there.

    Even from the more protectionist legislators, the gist of what they were saying was that the trade deficit was unfortunate, and while measures should be taken to prevent it from getting worse, there isn’t much that can be done to reverse what’s already happened. However, they presented imports from China as the worst imports, and the version of the deal that was actually passed contained a number of country-of-origin provisions to prevent Chinese goods passing through Central America from benefitting from free trade.

    Similarly, those backing the free trade deal took every point to say that it would be better to import textiles from Central America than from China.

    All this is just to say that any action along these lines would be an expression of Sinophobia, not so much one of attempting to restore a trade balance. In fact, all it would probably do is make India the principal Discount Manufacturer to the West.

  23. “To give the feel of things from the west side of the pond”

    Thanks for this Robert, and for reminding us all that the US CA deficit is not simply a US/China issue.

  24. i should write about kate moss more often … my track back function doesn’t work too well, particularly if you have anti-spam measures in place, so don’t hestitate to let me know when you have an interesting thread going over here –i arrived a bit late to this party.

  25. Incidentally Joerg and/or anyone else interested in academic treatment of this topic:

    “BTW, people who believe that interest rate differentials are the sole driver of currency fluctuations”

    You might be inteerested in the fact that Menzie Chinn is guest posting at James Hamilton’s EconBrowser and has this:

    One recent paper coauthored by myself, Yin-Wong Cheung and Antonio Garcia Pascual examined the long horizon (1 quarter, 1 year and 5 year) predictability of the USD against the DM, Yen, Pound, Swiss Franc, and Canadian dollar. We compared several popular models….We found that, using a mean squared error criterion, there was little evidence of outpredicting a random walk, although at long horizons, interest differentials did the best.

    http://www.econbrowser.com/archives/2005/10/whither_the_dol.html

    Mind you on this point:

    “shouldn´t even dream about putting money into the currency markets for anything but long periods of time.”

    he does add (:))

    Of course, you may lose lots of money if you try to exploit this relationship, since the interest parity relationship, even at the long horizon, is not a strong one (the adjusted R-squared from the regression of 5 year changes on 5 year interest rates is 0.05). At the short horizon (one month, 3 months), don’t even try using this for G-5 currencies — the forex traders make plenty of money betting against this relationship (it’s called the carry trade).

  26. I jost followed your trail here edward…
    To reask you this question :
    do you see any link between demographics and debt accumulation.

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