ECB back at its futile game

My former student alerted me to the European Central Bank going back to monetary easing. Such was the power of its previous spell of sustained monetary easing and ‘whatever it takes’ efforts that, in less than a year, after ending its asset purchases, it had to go back to the tried-tested-and-failed policy. Here is the press release.

ECB’s deposit facility rate has been ‘cut’ further to -0.5%. Now, this announcement says ECB will buy even private sector bonds with yields below the deposit facility rate! Oh, yes, that means that bond purchases have resumed at EUR20.0bn rate per month until such time that interest rates begin to rise. QE Infinity!

Additional monetary easing measures can be found here and here. Banks will not have to pay the deposit facility rate to the European Central Bank for keeping excess reserves with it! How considerate of bank profitability!

In the meantime, the same former student forwarded these remarks by the Vice-President of the European Central Bank in a speech made in Rome in June 2019:

In this context (favourable macro conditions), it is important to recall that the overall effect of our monetary policy on bank profitability has so far been broadly neutral. Nevertheless, the overall effects of negative rates on the banking sector need to be carefully monitored, particularly because the balance of their effects will depend on how long rates remain in negative territory [Link]

Good luck to European banks!

Over-rated and fallible

While monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rule book for international trade. Our challenge now is to do what monetary policy can do to sustain the expansion.

Remarks attributed to Jerome Powell, made at Jackson Hole Central Bank Symposium in August. This is my source. Monetary policy is not a powerful tool that helps any of the above. It is a limited tool that works under very specific circumstances. Experience has taught us that.

After so many years of egging on central banks to go negative, etc., Summers has found religion. He says central bankers are powerless. It is too late and he may well be abandoning a sinking ship. A tweet-storm or tweet thread on this is here (HT: Niranjan Rajadhyaksha). Tweets 18-24 under this thread are the important ones:

In contrast under the secular stagnation view we have outlined – what might be called “new old Keynesian” economics – interest rate cuts, even if feasible, may be at best only weakly effective at stimulating aggregate demand and at worst counterproductive.

There is the further point that reducing interest rates may degrade future economic performance for any of the following reasons.

First, financial instability. The financial crisis had roots in bubbles & excessive leverage caused by efforts to maintain demand after the 2001 recession. Japan’s late 1980s bubble had roots in a low interest rate tight fiscal environment after the 1987 stock market crash.

Second, risks of zombification of firms. Firms that do not face debt service payments are like students who do not have to take tests. They can drift along complacently & ultimately unsuccessfully. And low rates may contribute to increased monopoly power and reduced dynamism.

Third, risks of bank failures. Low rates crowd bank profits and franchise value, making them more vulnerable to adverse shocks at any given level of regulatory capital.

Fourth, risks of further reducing monetary policy effectiveness. To the extent to which rate cuts now “borrow” demand from the future as firms and consumers bring forward investment and durable purchases, low rates now may imply less effective monetary policy in the future.

The right issue for macroeconomists to be focused on is assuring adequate aggregate demand. We believe it is dangerous for central bankers to suggest that they have this challenge under control – or that with their current toolkit they will be able to get it under control.

I hope the last tweet is not the harbinger of more hare-brained approaches. Summers (and his friends in the academia in the United States who still swear by monetary policy effectiveness) would do well to reflect on this speech by Graeme Wheeler, former Governor of the Reserve Bank of New Zealand made in October 2015. It is not secular stagnation in aggregate demand. It is secular stagnation in trend growth. That is the nature of the game. The answer to the question of where inflation is, if trend growth is weak as well is that inflation is driven by wage dynamics. Labour has been stifled and its pricing power emaciated for last four decades. It has not come back. As long as that is the case, conventional inflation rate (CPI index change) is the wrong place to look for deficient or excess aggregate demand. That was the mistake pre-2008 and now post-2008 too.

Summers’ ‘revelations’ carry no trace of him having preached something very different all these ears. Some acknowledgement of the errors of his past world view would be the intellectually honest thing to do.

Four Governors of the Federal Reserve wrote a joint op.-ed., urging the American President to respect the independence of the Federal Reserve. Not quite directly but that was the intention. Their effort was undone by an op.ed., by William Dudley (a Goldman Sachs Alumni), former President of the Federal Reserve Bank of New York in which he urged the Federal Reserve not to offset the damage President Trump might be causing the American economy with his ongoing dispute with China and also to tweak policy to thwart his re-election chances! It is unclear as to whom he is batting for. It was clear whom he was batting against.

Best response to William Dudley came from Michael Lebowitz:

Dudley really has some nerve. The Fed, with Dudley’s help for ten years, lays tons of economic tinder for economic troubles and then he places blame on the potential spark (Trump). [Link]

STCMA on August 1, 2019

Pakistan rolls back the increase in cooking gas tariffs for roadside roti/naan outlets. [Link]

Ruchir Sharma’s piece in Times of India on July 31 echoes what I wrote for Mint on July 26:

Japan showed that central banks can print all the money they want, but can’t dictate where it will go.

Authorities in the Chinese capital have ordered halal restaurants and food stalls to remove Arabic script and symbols associated with Islam from their signs, part of an expanding national effort to “Sinicize” its Muslim population. [Link]

OF course, none of these seem to matter for Stephen Roach who sees nothing ‘red’ in China.

His tally of assets at a broader universe of Chinese lenders in “distress” is 9.2 trillion yuan, or about 4% of the commercial banking system and nearly 10% of gross domestic product. [Link]

The UBS analyst, cited above, is being careful, to sound positive (if you read the full story) so that he avoids the fate that befell his economist-colleague

I think what Raghuram Rajan is saying here is that central bankers have become the fall guys because they set themselves up to be supermen and women. It is time for a confession.

Business Today carried an useful article on tech. applications that are considerate to our privacy concerns [Link]

A friend had flagged this. It is indeed nuts. See Ruchir’s piece above too.

The analysis by S&P Global Market Intelligence found unrated entities in China, the U.K. and the technology sector in Asia Pacific are among the most at risk of a sudden spike in defaults. [Link]

Jeffrey Frankel is not sure whether inflation targeting really works because we still do not know, after all these years, how inflation expectations are formed. At least, one interesting link to a paper in his piece. [Link]

Finally, Google gets rid of another employee who is a conservative Republican.

Which inflation to fight?

The lesson, to me, is crystal clear. Deflation is a threat posed by a critical breakdown of the financial system. Slow growth and recurrent recessions without systemic financial disturbances, even the big recessions of 1975 and 1982, have not posed such a risk. The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk-taking, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the “easy money,” striving for a “little inflation” as a means of forestalling deflation, could, in the end, be what brings it about. That is the basic lesson for monetary policy. It demands emphasis on price stability and prudent oversight of the financial system. Both of those requirements inexorably lead to the responsibilities of a central bank.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 227). Public Affairs. Kindle Edition.

This is the lesson that central banks in several advanced nations have ignored repeatedly in the last decade and are preparing to ignore again, in 2019

Volcker-William Sharpe conversation

I found myself sitting in the audience next to William Sharpe, a 1990 Nobel laureate in economics whose “Sharpe ratio” has become a widely accepted measure of risk-adjusted returns for fund managers. I nudged him and asked how much this new financial engineering contributed to economic growth, measured by GNP. “Nothing,” he whispered back to me. It was not the answer I anticipated. “So what does it do?” was my response. “It just moves around the [economic] rents* in the financial system. Besides it’s a lot of fun.” (Later, at dinner, he suggested the possibility of small ways in which economic welfare could be advanced, but I felt I had already gotten the gist of his thinking.) 

Source: Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 206). Public Affairs. Kindle Edition.

Here we are, a decade after the crisis, and the scurrying lobbyist chipmunks are nibbling away in the name of efficiency and simplification (good, in itself), but with the ultimate aim of weakening the new safeguards.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 209). Public Affairs. Kindle Edition.

I am sure Tim Geithner and Larry Summers would have been content if I disappeared. The potential for conflict in policy approaches was real.

Volcker, Paul. Keeping At It: The Quest for Sound Money and Good Government (p. 212). Public Affairs. Kindle Edition.

In my view, ‘Keeping at it’ was a good book but not a great book. He is a master of understatement. Mr. Volcker’s transparent sincerity, simplicity, impeccable integrity came through. But, he was not going to make scathing statements or judgements on any one. That is a testimony to the man’s character but that also makes the book somewhat duller. One has to pierce through his statements to understand what he left it for readers to figure out. One example is the comment on Geithner-Summers above.

Non-economists at central banks

I am not sure whether my friend Amol Agrawal’s piece in Business Standard is a lament or praise for the fading of economists from high seats in the world of central banking. It seems to be a factual article leaving much unsaid. Perhaps, he is training to become a central banker!

I do feel, for the record, that governments should allow independent institutions to exist within the government framework. But, they cannot become alternative power centres and be vocal about their differences with the government. But, they should be voices of conscience and they should focus on the long-term objectives of governance which can be different from the short-run goals of those who govern. Therein lies the tension. On those occasions, they must speak out with restraint, firmness, confidence and politeness but must avoid grandstanding. If they fail, they should leave, rather than make the situation worse for the country with a messy fight.

Paul Volcker had his run-ins with James Baker, Treasury Secretary under Ronald Reagan in his second term. He mentions the post-Plaza Hotel Accord incidents. The communication committing the G-5 (Canada and Italy were added later to become G-7) to monetary easing was opposed by Volcker. Soon, he faced an insurrection inside the Federal Reserve Board. He did not resign nor did he do grandstanding then. He left at the end of his second term although originally he had planned to serve only two years of his second term. That seems like a better way of handling differences. (Source: ‘Keeping at it’ by Paul Volcker)

Ninan’s missed opportunity

Last weekend (June 29, 2019), T.N. Ninan wrote an article on the departure of Viral Acharya from RBI. He is the Deputy Governor. His first term ends in January. He is leaving six months ahead in July.

Viral Acharya has been personally courteous to me. In fact, when I pointed out that RBI surveys (quarterly surveys) should be captured in Excel for download and analysis, he quickly set the ball in motion and it became a reality. Now, we can download the survey results and do analytical stuff with it.

That is not the point. His departure is neither the end-of-the-road for RBI independence nor is it an embarrassment for the Indian government.

Ninan writes:

Similarly, those within the Indian government system do not speak out publicly against the government they serve. When you are the governor or deputy governor, you do not have the freedom of speech that an ordinary citizen enjoys. Differences are aired only internally. On the occasions when someone feels the need to start a public debate, it is not done in apocalyptic terms. Naturally, when Dr Rajan and Dr Acharya spoke out bluntly (in the case of the former, on issues with which he was not officially concerned), it did not go down well.

No employer will allow their employees to speak out against them publicly when you are still working for them. No private sector enterprise would allow that. Nor, for that matter, do foreign governments – even those in developed countries – allow that.

Independence of the central bank does not mean that they cannot be questioned. It does not mean that they are not accountable to anyone. If they are forced to overturn a decision taken in public interest by the sheer weight and force of authority without logic, that is an assault on institutional independence.

Indeed, those who brandish independence as the first line of defence against and all criticisms are the ones who are shutting out debate.

I was happy to see the header in a MINT report on RBI’s revised circular on the recognition of non-performing assets after the Supreme Court struck it down. The report said that the new circular was an exercise in humility. Well said. I found the new circular pragmatic and it did not sacrifice credit discipline.

Mr. Ninan concludes his article thus:

Today, with growth having slowed and macroeconomic challenges in every direction, would the government have benefited from the advice of “Harvard” economists? Perhaps, but judging by past record it probably would not have paid much heed.

Is that so? But, Andres Velasco provides a counter perspective. India, probably, does not miss much or would not miss much.

Mr. Ninan has missed an opportunity to write a more useful piece. That is a pity because he is one of the more perceptive, experienced and balanced commentators in the country.