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At the other extreme . . .

A quick follow up to my previous post.  Australia has seen 3% RGDP growth over the past 12 months, and 2.7% the year before, and 3.6% the year before.  Great news eh?  Here’s Australia’s unemployment rate over Screen Shot 2014-11-18 at 9.56.23 AMthe past 12 months:

That’s what happens when you have a high trend RGDP growth rate.

 

The real “beggar-thy-neighbor” policy

Proponents of fiscal stimulus often call on Germany to adopt a more expansionary fiscal policy, in the hope that this will help rebalance and reflate the entire eurozone.  It’s possible it might work, but it’s also possible it might end up being a “beggar-thy-neighbor” policy.

Suppose the ECB is targeting inflation. Fiscal stimulus in Germany will be partly offset (in Germany) by tighter monetary policy. The ECB will want to keep overall eurozone inflation on target.  Hence it will offset any impact on NGDP.  But some of the effect of tighter eurozone monetary policy will be felt in the other countries. So if total eurozone NGDP and inflation are unaffected by the two policy changes, and German NGDP rises, then it is necessarily true that non-German NGDP falls.

Possible objections:

1.  The ECB would never be that cruel.  It’s not about the ECB being cruel; it’s about the ECB doing its job.  A better counterargument is that the ECB is incompetent and won’t do its job.

2.  The argument doesn’t apply at the zero bound.  I would remind you that during over 90% of the past 6 years the ECB has been doing normal monetary policy, raising and lowering its interest rate target with the goal of stabilizing inflation.  Only very recently has it hit the zero bound.  And yet people have been calling for German fiscal expansion for years.  And it’s also worth noting that fiscal proponents who claim that the zero bound “changes everything” were spectacularly wrong in their 2013 prediction that austerity would slow growth in the US. That doesn’t mean that monetary offset applies in each and every case—the ECB is unusually incompetent, but it’s certainly the baseline assumption.

3.  This is one of those ivory tower theories that don’t match the real world.  And yet the idea of fiscal stimulus being a beggar-thy-neighbor policy is actually the standard textbook explanation for the European exchange rate crisis of September 1992.  Germany did a massive fiscal stimulus in the early 1990s, to help rebuild East Germany.  This pushed up real interest rates in the ECU area. The higher real interest rates (combined with a Bundesbank monetary policy tight enough to prevent inflation) led to recession (or aggravated an existing recession) in countries like Britain and Sweden.  Eventually they were forced to devalue, and to this day remain outside of the euro.

So fiscal expansion in one country within a currency zone is a beggar-thy-neighbor policy in both theory and practice.  Over at Econlog, I have a new post explaining why low interest rates do not call for more public investment.

Haruhiko Kuroda = Franklin Delano Roosevelt

In April 1933 FDR stunned the markets, the pundits, and his own administration by devaluing the dollar.  In June 1933 he stunned everyone again by blowing up the World Monetary Conference, which was trying to restore a fixed exchange rate regime.  In October 1933 he stunned everyone again with his “gold-buying” (i.e. dollar depreciation) program, which caused some of his top officials to resign in protest.

In 2003 Ben Bernanke said Japan needed “Rooseveltian resolve.”

A few years later almost all of the major developed economies needed Rooseveltian resolve.

And today the central banker that best illustrates Rooseveltian resolve is the head of the BOJ, Haruhiko Kuroda.

The Bank of Japan Governor not only surprised the markets with his latest splurge of monetary easing. He sprang it on his own board members just two days earlier, jolted into action to stop them making a low-ball forecast that might have sunk his flagship inflation target.

To achieve maximum effect for the shock decision, Haruhiko Kuroda and right-hand man Masayoshi Amamiya kept only a handful of elite central bank bureaucrats in the loop as they laid the ground for the expansion of their quantitative and qualitative easing (QQE) programme.

They didn’t even give the usual forewarning to senior bureaucrats at the Ministry of Finance, according to interviews with nearly a dozen insiders and government sources with knowledge of the bank’s deliberations.

.  .  .

Timing was critical – and not of his choosing. At the policy meeting the board would also issue a new consumer inflation forecast for the next fiscal year, based on the median estimate from the nine members. But two days before publication, the preliminary estimate was only around 1.5 percent, three of the sources said.

That was well below the 1.9 percent forecast made in July, and if published could have been fatal to his key goal of hitting 2 percent from April next year. Since price expectations play a key role in the consumer behaviours that ultimately determine prices, doubts about the target could be self-fulfilling.

.  .  .

It worked. They revised their forecasts to take account of the QQE injection, bringing the figure up to 1.7 percent, enough to keep Kuroda’s target within sight and perhaps drain the growing pool of doubters.

That’s about as close to a Svenssonian “target the forecast” approach as I’ve ever seen.

Though Kuroda won the vote, which will boost the BOJ’s government debt purchases by $260 billion a year and triple its buying of risky assets, he also paid a price for the manner and haste of the decision: a board split almost down the middle.

Because policy board members are barred from discussing policy without a quorum in a formal meeting, Kuroda sent BOJ bureaucrats as his emissaries to corral a majority for his easing plan, sources said.

He knew he had the votes of his two deputies, and that there was no hope of winning over the board’s two market economists who have long expressed public doubts about QQE, especially Takahide Kiuchi, who wants the programme terminated in two years.

So fierce lobbying focused on the board’s two former businessmen, Koji Ishida and Yoshihisa Morimoto.

Despite frantic efforts, he failed to win them over. Worse, though they had rarely voiced open doubts about QQE before, their opposition would now become public.

The sources said the swing voter was the hard-to-predict former academic Ryuzo Miyao, who took a long time to convince.

One suggested Kuroda had let a genie of dissent out of the bottle, which could make future easing decisions more difficult to achieve.

Yes, but elected officials have the last word:

Takeshi Minami, chief economist at Norinchukin Research Institute and one of just four of the 19 economists who had correctly forecast the Halloween surprise in a Reuters poll, expects the bank will want to ease again in mid-2015.

If so, Kuroda, whose determination to stay the course is unflagging, could well need Prime Minister Shinzo Abe to stack the BOJ board with reliable reflationists when Miyao’s term ends in March and Morimoto’s in June.

“In order to completely overcome the chronic disease of deflation, you need to take all your medicine,” Kuroda said on Wednesday. “Half-baked medical treatment will only worsen the symptoms.”

A lesson the ECB has yet to learn.

 

Svensson, vindicated.

I once read a book where Richard Rorty debated another philosopher on the nature of “truth.” Rorty claimed something to the effect that; “Truth was what your colleagues let you get way with.”

The other philosopher countered with a hypothetical.  Suppose someone says: “Most people believe X is true, but I believe that Y is actually true.”  Clearly they’d have in mind a different conception of truth.  Rorty countered that claiming something not widely believed is “actually true” is implicitly a prediction that it will be accepted as the truth at some point in the future.  That doesn’t always work, but it’s an interesting way of thinking about truth.

In any case, it can now be said that Lars Svensson’s critique of Riksbank policy has been proven “true” in the sense that his opponents have now recognized it as true (the following is from the excellent Ambrose Evans-Pritchard):

Sweden’s Riksbank has torn up the rulebook of global central banking, cutting interest rates to zero even though the economy is in the grip of a credit boom.

The extraordinary step is intended to stave off deflation but it comes at a time when the Swedish economy is growing at almost 2pc and property prices are rising briskly. The bank has abandoned earlier efforts to curb asset bubbles by “leaning against the wind”.

The Riksbank cut the deposit rate to -0.75pc in what looks like a preparatory move to drive down the krona. Governor Stefan Ingves said the bank has a toolkit of extreme measures in reserve, including use of the exchange rate.

If the Riksbank was caught off guard, it’s because they weren’t paying attention to the only world class monetary expert on their committee.

The Riksbank has in effect washed its hands of the credit boom, leaving it to government regulators to control household debt with mortgage curbs, liquidity limits for banks and other “macro-prudential” tools as best they can.

You mean regulators should deal with specific problems in a specific sector of the economy with a scalpel?  I thought the central bank needed to deal with the housing market with a sledgehammer, smashing the entire economy.

“What the Riksbank is doing is something that a lot of central banks around the world are going to have to do: once interest rates approach zero, they are forced to think about far more radical instruments,” said Lars Christensen, from Danske Bank.

The Riksbank – arguably the world’s oldest central bank, with a tradition of bold monetary experiments – carried out a dramatic volte-face in July when it slashed rates and gave up trying to restrain asset prices. Governor Ingves was outvoted in what amounted to a policy mutiny.

The shift over recent months is a triumph for Mr Svensson, who resigned last year in a stormy dispute. He said the bank made a mistake by tightening before the economy had fully recovered, and then compounding the error by allowing itself to be distracted by the noise of asset bubbles. “Low inflation has actually increased the households’ real debt burden. Riksbank policy has been counterproductive,” he said.

Svensson, vindicated.

The Riksbank is now fully aligned with the Yellen Fed in Washington, which argues that raising rates to stop asset bubbles merely destroys jobs for little useful purpose. Both are pitted against the Bank for International Settlements. The BIS says radical monetary stimulus may help individual countries but only by displacing the problem onto others, leading to a “Pareto sub-optimal” for the world as a whole. It warns that speculative excess is reaching pre-Lehman levels, and calls on global central banks to take pre-emptive action before the bubbles becomes unmanageable.

What is far from clear is whether the Riksbank can get away with such policies. It may run into harsh criticism from rest of the world if it is seen to engage in “beggar-thy-neighbour” stealth devaluation at a time when the Swedish economy is expected to grow 2.7pc next year, and has a current account surplus above 7pc of GDP.

Does the BIS think the eurozone is a bubble?  How much tighter should ECB policy be?  As an aside, Sweden’s a good example of why people should never, ever reason from a current account surplus.  It tells us nothing interesting about the business cycle.

Sweden was one of the first central banks to adopt price level targeting, in the early 1930s. In an intellectual sense, the ECB is at least 80 years behind Sweden:

The institution enjoys a prestige beyond its size, a legacy of the great Swedish economists of the early 20th century: Knut Wicksell, Gustav Cassel, Bertil Ohlin and Gunnar Myrdal. It is watched closely as a pioneer in central bank theory.

The bank famously began “price targeting” in the early 1930s after breaking free from the Gold Standard. The revolutionary policy was the precursor of today’s inflation targeting. It enabled Sweden to escape deflation early in the Great Depression, suffering far less damage than countries that stuck doggedly to failed orthodoxies.

And speaking of monetary innovators, the intellectual leader of market monetarism was recently interviewed by Erin Ade on Boom/Bust (at about the 3 minute mark.)  He is just as good at explaining ideas verbally as in print. But he looks slightly different from what I expected.

HT:  TravisV, Saturos

Readers of TheMoneyIllusion are not confused

Headline from Yahoo:

Yields Rally as FOMC Signals QE Likely to End in October

Is that the real reason yields rallied?  Stocks also rallied, and the media reported the statement was slightly more expansionary than expected, due to the “considerable period” language.