North America takes control of European central banking
What a nice Fourth of July present for us Americans! With today’s moves it looks like ideas from the New World are sweeping across the Old World. And investors are taking notice:
The Bank of England told financial markets on Thursday they were wrong in expecting interest rate hikes relatively soon, in Mark Carney‘s first significant policy signal as the new governor.
Introducing an element of “forward guidance” into the Monetary Policy Committee’s statement on the economy in saying the market’s recent expectations of rate rises in 2015 “were unwarranted”, the BoE has broken with its tradition of not commentating on market movements.
Sterling fell sharply against other currencies and equity prices jumped after the bank’s move, which investors took as a sign the central bank was likely to remain dovish under its new governor. But forward interest rate markets did not move fully back to the expectation in May that the first rate rise would wait until well into 2016.
British stocks rose 3%. The economic news out of the UK was also strong, but of course that doesn’t explain why the pound fell from 1.52 to 1.50.
A few hours later the ultra-conservative ECB took baby steps into the Bernanke/Carney world of forward guidance:
FRANKFURT (Reuters) – The European Central Bank will keep interest rates at record lows for an extended period and could yet cut them further, the bank’s chief, Mario Draghi, said on Thursday.
Less than two hours hour after the Bank of England gave a steer about future interest rate moves at Mark Carney’s debut policy meeting as governor, the ECB president adopted the same tactic.
“The Governing Council expects the key ECB rates to remain at present or lower levels for an extended period of time,” Draghi told a news conference after the ECB left interest rates at 0.5 percent, emphasizing that this was the first time that the ECB had done so.
And Draghi hinted that more steps may be taken if the eurozone economy doesn’t do better:
The ECB left its main refinancing rate at 0.5 percent and the deposit rate at zero, as was expected by economists in a Reuters poll.
“50 basis points is not the lower bound,” Draghi said.
On a day when Americans celebrate their independence from Britain, the Old World becomes ever more dependent on ideas from North America.
PS. The euro also fell. US stock futures jumped on the good policy news—so much for “beggar-thy-neighbor” theories. It’s a positive sum game.
HT: Vaidas
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4. July 2013 at 07:49
“Ever more dependant”? God help us. Woodford got us into this mess, damn right he should help get us out.
“Have a nice day!” 😉
4. July 2013 at 08:10
Commonwealth and all that, but congratulations on your independence. July 1, was our big day up here in BNA. http://en.wikipedia.org/wiki/British_North_America_Acts
4. July 2013 at 08:14
Stock markets always go up when central banks get more dovish. Yet, you seem invariably to cite such market rises as evidence that monetary policy is correct, or at least getting more correct. How can an indicator that always points in one direction (more dovish = good) be used as an indicator of what correct monetary policy should be? I am fairly certain that if and when the Fed reaches the point where the “optimal” (by your metric) policy stance is to tighten, that the stock market will go down, indicating that it is the wrong move. Will you continue to cite equity moves as a valid indicator? I am not talking here about whether the central banks should target equity prices — that is a different question, and you have stated quite clearly that they should not. I am asking why you continue to use reactions of the equity market an indicator that a policy move was correct or incorrect for the economy as a whole. Equity markets will always signal in favor of more loosening. The way I look at it, that makes them largely meaningless indicators for monetary policy.
4. July 2013 at 08:14
Yes, today was an important day, although hardly surprising.
By the way – I reckon you aren’t worried about Abe’s plan to hike consumption taxes next year as an opening shot for fiscal consolidatio as long as the BOJ keeps pushing the pedal to the metal? (Assuming it does?)
Happy 4th July over there,
4. July 2013 at 08:15
Will be raising my glass to market monetarism today, as well as the US. Happy Independence Day Scott.
4. July 2013 at 08:42
maynardGkeynes,
It is more complicated than “Stock markets always go up when central banks get more dovish.”
The ECB has never indicated that it will tolerate above 2% inflation. When markets perceive a risk of inflation going above 2%, then markets will know that tightening is imminent and will not respond positively to more monetary stimulus.
If central banks were changing long-term inflation targets, then you would have a point. But, that isn’t what’s been happening in the US, UK, or Europe. It’s not even clear if the correct terminology these days is hawkish vs. dovish. Many central bankers (although maybe not Draghi) agree that 2% is a good long-term inflation target. The disagreement is about whether central banks can do anything in the current situation to boost employment/inflation to target levels. A central banker who believes he/she is not out of ammunition and will try to help the economy is not necessarily more dovish but just more correct. And when such a central banker pushes the economy too far (and still maintains that the target inflation rate is 2%), markets will know that tightening is just around the corner.
4. July 2013 at 08:59
“50 basis points is not the lower bound,” Draghi said.
This quote is worthy of a blog post all of it’s own.
4. July 2013 at 09:17
Question: how much monetary easing does the U.K. really need? What’ve been their NGDP growth and inflation rates lately?
4. July 2013 at 09:28
‘The Bank of England told financial markets on Thursday they were wrong in expecting interest rate hikes relatively soon….expectations of rate rises in 2015….forward interest rate markets … the expectation in May that the first rate rise would wait until well into 2016.
‘….The European Central Bank will keep interest rates at record lows for an extended period….’
All of which should make any self-respecting Market Monetarist want to tear his hair out.
4. July 2013 at 09:29
@J My use of “always” is too strong a term, but the Bernanke Kuttner paper suggests a very strong and persistent positive reaction to reaction to “surprise” rate cuts.
“The results presented in section 2 of the paper show that the market reacts fairly strongly to surprise funds rate changes. Specifically, for a sample consisting of the union of days with a change in the target funds rate target and days of meetings of the Federal Open Market Committee (FOMC), we estimate that the CRSP value-weighted index registers a one-day gain of roughly one percent in response to a hypothetical surprise 25-basis-point easing. The market reacts little, if at all, to the component of funds rate changes that are anticipated by futures market participants…..These results are broadly consistent with those of other studies which have looked at the link between monetary policy and the stock market.”
What Explains the Stock Market’s Reaction to
Federal Reserve Policy?
Ben S. Bernanke Kenneth N. Kuttner∗
March 2004
4. July 2013 at 10:31
Scott
Even in Brazil, where the stock market dropped 20% since the infamous May 22 FOMC minutes and Bernanke´s ‘gauche’ testimony, the BoE and ECB news is responsible for a 2.5% gain so far today (despite continuing bad internal news).
4. July 2013 at 10:46
Maynard, I do not now and never have regarded stock market movements as an indicator of whether policy is appropriate. Rather I regard the stock market response as an indicator of whether these policy initiatives boosted NGDP growth expectations. I believe they did. I also believe that both Britain and the eurozone would benefit from faster NGDP growth, but for reasons unrelated to the stock market.
Don’t forget that stocks did very poorly during the high inflation policy of 1966-81.
Mikio, I am very worried about the higher sales tax, which is an adverse supply shock. The BoJ could offset the effect, but I’m not at all confident they will.
Travis, Good question; I’d check out Britmouse’s blog, he’s the expert. My sense is that they need slightly higher NGDP growth, but much less than the eurozone.
4. July 2013 at 11:54
“Maynard, I do not now and never have regarded stock market movements as an indicator of whether policy is appropriate. Rather I regard the stock market response as an indicator of whether these policy initiatives boosted NGDP growth expectations.”
I’m don’t see any difference in practical terms, since NGDP growth expectations (as allegedly indicated by equity markets) are at the core of what you believe correct monetary policy should be, but I very much appreciate your taking the time to respond to my question/comment.
4. July 2013 at 11:55
Maynard and ssumner,
I would argue that stock valuations rise as expected NGDP approaches 4-6%, but valuations fall off if expected NGDP is below OR above this range.
Should the Fed target high stock valuations?
No, in the sense that it isn’t their business to make existing investors richer, nor to increase the capital share of national income.
Yes, in the sense that stable 4-6% NGDP assists in capital formation by reducing the costs of self-insuring against nominal shocks.
4. July 2013 at 12:06
Scott, off-topic but when is your book on the Depression scheduled to come out?
4. July 2013 at 12:31
But where are the concrete steps?!
maynardGkeynes,
See the work David Glasner has done on his blog. In the 1970s, the Dow reacted unhappily to rising inflation expectations.
4. July 2013 at 13:01
maynardGkeynes,
The results in that paper may stem from rate cuts when money was too tight. But, I haven’t read the paper so maybe you are right.
Anyway, as Sumner says, if stock market prices follow NGDP expectations, then they are not an indicator of good policy vs. bad policy but an indicator of NGDP expectations. When NGDP is too low, then rising stock prices demonstrate that QE is helping get NGDP to where it should be. When NGDP is where it should be, then none of this matters.
4. July 2013 at 13:09
Maynard, I’m not sure what you are confused about. Suppose the Fed eased, stocks rose, but I thought NGDP growth expectations were already excessive. Obviously in that case I would not regard stocks as a useful indicator of whether monetary policy was appropriate.
Steve, But I doubt stock prices are a good indicator of when NGDP growth is optimal.
AD, Later this year.
4. July 2013 at 13:51
And to think the MPC majority said they wouldn’t be bounced into more easing by anybody, not even a new Governor. Having consistently outvoted the old Governor for several months on more QE, I’m almost disappointed the majority caved so quickly. I think that majority on the MPC should now all resign and leave Carney to appoint a tougher, smarter bunch.
Or maybe it was all just a cunning plan designed to bounce the new Governor into doing what the old Governor never understood: that one short sentence is worth £100bn of QE. A few short sentences more, including “NGDP’targeting” and we’ll be unwinding QE within months, and no one will notice.
Who knows, the idea might even spread to the US Federal Reserve. That would be one in the eye for all you Yanks, slavishly following British monetary policy. Remember Carney has taken British citizenship.
A happy 4th July indeed!
4. July 2013 at 14:22
Professor Sumner,
You said: “Steve, But I doubt stock prices are a good indicator of when NGDP growth is optimal.”
If we switched to a NGDP level target regime, then wouldn’t stock prices be a pretty good indicator of when NGDP growth is optimal (in this ideal world we would have a NGDP prediction market so this question would be purely academic)? Expectations of above target NGDP would lead to expectations of below average NGDP growth in the future (after the above target numbers came in). Either way, the NGDP level in two years (or two quarters) would be expected to be fixed (any overshooting after year one would be compensated for in year two), so not optimal NGDP expectations in either direction would just lead to noisy monetary policy and a worse economy.
5. July 2013 at 05:33
James, And let’s not forget that both the US and Canada are British creations, at least indirectly.
J, I think you both are forgetting the fact that while NGDP does affect the stock market, lots of other things do as well. Stocks have soared in recent years without any change in NGDP growth expectations.