There’s a great new Wall Street Journal article that begins as follows:
In the seven years since the world’s central banks responded to the financial crisis by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat.
But it’s never their fault:
Riksbank Deputy Governor Per Jansson, in a 2014 speech, responded to critics saying, “with hindsight, it is clear that monetary policy could have been somewhat more expansionary if we had known that inflation would be as low as it is now.” But, he said, “This is a natural and unavoidable consequence of the fact that monetary policy has to be based on forecasts, which are uncertain.”
Former ECB President Jean-Claude Trichet, who pushed eurozone rates up in 2011, said he needed to react to rising inflation driven by commodity prices and a threat that households and businesses might expect higher inflation rates in the future. The ECB’s mandate was for inflation near 2%, and the ECB delivered “exactly what we promised” during his term, he said in an interview. Subsequent rate reductions happened after he left and the inflation backdrop shifted, he said. Mr. Trichet said he used other measures to combat financial turmoil, including bond purchases and emergency loans to banks.
Per Jansson doesn’t tell the WSJ readers that the Riksbank’s own internal inflation forecast predicted failure, as inflation was expected to remain below target even without a rate increase. Lars Svensson was so exasperated he resigned in protest. The Riksbank was clearly violating its legal mandate to target inflation.
Regarding Trichet, I don’t know whether to laugh or cry. Imagine someone named Trichet racing to the edge of the Grand Canyon at 100 mph. Besides him sits Mr. Draghi. Just before he reaches the edge of the canyon, Trichet rips off the steering wheel and hands it to Draghi. Here, you drive. And then he jumps out the window.
Heh, we hit the inflation target under my watch, it was my replacement who fell short. Don’t blame me.
For years, the Paul Krugmans of the world have been telling us the Eurozone Depression is so deep that monetary policy isn’t enough, we also need fiscal stimulus. At the same time the Trichets of the world are raising rates to prevent eurozone overheating. You can’t make this stuff up, it’s just too bizarre.
Who am I to question the wisdom of the central bankers of the world? They are often much more distinguished than I am. In fact, I don’t trust my own judgment; I presume that Yellen and Fischer are much better monetary economists than I am. But it seems the markets also think the Fed is wrong:
Fed officials now say they plan to move gradually. But their expectations for rates could still be too high. Officials in June estimated the Fed would raise the short-term federal-funds rate from near zero now to 1.625% by the end of 2016 and to 2.875% by the end of 2017.
Investors have a different view. Fed-funds futures markets, where traders place bets on the outlook for the central bank’s benchmark interest rate, put the Fed target at under 1% at the end of 2016 and under 1.5% at the end of 2017. In anticipation of the Fed’s next policy meeting, some officials have said they expect to reduce their projections for rates in the future. Their projections for where rates will end up in the long run have drifted down by a half percentage point in the past three years.
Yup, they’ve “drifted down” and they’ll keep drifting down, as long as central bankers think they are smarter than the markets.
As you read the following, think about how the real risk free interest rate is determined in global markets. Then ask yourself how much success the Fed is likely to have against this backdrop:
Mario Draghi’s promise that the European Central Bank is willing to step up its stimulus if needed is resonating with economists, who see the euro-area recovery as too shallow to be sustained.
More than two-thirds of respondents in a Bloomberg survey predict the ECB’s president will expand or extend the 1.14 trillion-euro ($1.3 trillion) quantitative-easing program, and almost all of those say he’ll do so within nine months. While an increasing number of respondents see the economy improving for now, they’re also fretting that the upturn won’t last long.
The ECB’s Governing Council has already shown concern that a slowdown in global trade will erode exports, a pillar of the regional recovery, before domestic demand is strong enough to compensate. The central bank this month cut its growth and inflation forecasts and Draghi told reporters that QE is flexible in size, duration and composition. In contrast, the Federal Reserve may raise its interest rates as soon as this week.
“QE risks becoming a semi-permanent feature,” said Gianluca Sanna, a portfolio manager at Banca Monte dei Paschi di Siena SpA in Milan. “While it’s certainly true that the euro zone is indeed going through a phase of decent, maybe even above-potential, output growth, chances are that there is nothing self-sustaining in what we are seeing right now and the euro zone ends up again in a low-growth environment with inflation dangerously close to zero.”
I very much hope I’m wrong, just as I hope I’m wrong in my prediction that Chinese growth will come in well below the consensus.