Painfully sloppy

Independent central banks played a critical role in bringing inflation down in the 1980s and 1990s. But in the current low-inflation environment, their exclusive focus on price stability imparts a deflationary bias to economic policy and is in tension with employment generation and growth. [Link]

A shockingly sloppy statement from one of the world’s most thoughtful economists. That was from Dani Rodrik in his most recent column in defence of economic populism.

Central banks have cut nominal interest rates to zero. They bought assets; increased the quantum of assets they bought; increased the range of assets they bought; re-invested proceeds from the assets they sold back into the assets; they tried negative interest rates and yet, Dani Rodrik thinks they impart a deflationary bias?!!

Financial conditions have eased remarkably since the Federal Reserve allegedly began tightening in the U.S. in 2014. There is a massive inflationary bias to asset prices in the world now. Perhaps, the deflationary bias in the prices of goods and services is related to the inflationary bias that monetary policy has imparted to asset prices.

Not taking cognisance of any of these in a seemingly throwaway remark is disappointingly thoughtless for a man whose intellectual depth and understanding of global issues have raised the bar so high for him. He needs to be conscious of that


Baloney from Blanchard

Based on the Bloomberg story from the American Economic Association meetings:

The International Monetary Fund’s former chief economist saw what he called “suggestive” evidence that policy makers might be able to push joblessness below what is seen as its natural rate without risking higher inflation.

So what does that mean for the Fed? “There is a decent case” it should overheat the economy and try to attract more people into the labor force, said Blanchard, now a senior fellow at the Peterson Institute for International Economics in Washington. [Link]

Where do financial markets and bubbles figure in all this? Jobs that created in the real economy because monetary policy keeps nominal and real rates too low (well  below where they should be, for investors to be mindful of both risks and return) would be lost when the bubbles burst either because monetary policy eventually reverses or due to any other reason.

See this and this – conversation between Stanley Druckenmiller and CNBC host.


Interesting Powell

Zerohedge has done a blog post or two based on the transcripts of FOMC meetings of 2012 in which the Federal Reserve resorted to QE3. You can see the blog posts here and here. Of course, Jeffrey Lacker dissented in the September meeting when the Federal Reserve decided to purchase mortgage backed securities to the extent of USD40bn per month on top of the USD45bn of Treasury Securities it was already purchasing. It would have been interesting to read his comments. But, correctly, the market had decided to focus on what Powell said in those meetings. Check out the blog posts by Zerohedge. He had spoken well. It makes his stewardship likely interesting.

More than his remarks that were highlighted by Zerohedge, these remarks caught my attention and I will explain why:

In the new deal market, there’s a large industrial deal that I’m pretty familiar with that is being done at 6¼ times leverage in the next few weeks. It’s rated CCC by both Moody’s and S&P. In most ordinary markets there is no CCC market for paper, and this is being done at 6¼ times leverage with a weighted average cost of capital of under 6 percent. So private equity firms are more focused on the level than they are the spread, and under 6 percent for that kind of paper is an all-time record, again, very reminiscent of a bubble period. So demand for leveraged loans and high-yield bonds is far in excess of supply.

This can be expected to continue. On the bright side, you do not yet see the return of that leveraged mark-to-market structure that was so unstable in the crash, and you also don’t see very large deals getting done yet. There’s sort of a cap around $5 billion, and you don’t see dealers committing their balance sheets. I think all three of these things are positives for holding down the systemic risk aspects of this emerging bubble, if you will. But we’ve seen the competitive dynamic develop into a race to the bottom before, and so these markets are definitely worth keeping a close eye on.

He made these observations in the FOMC meeting of October 2012.  See p. 143 of the link. What is interesting is that if he saw leverage as a risk in 2012, how much of a risk would it be in 2018?

Hence, we have no idea of  what and how much would unravel when asset bubbles burst.

Raghuram Rajan’s first salvo for the year

Raghuram Rajan had fired his first salvo of the New Year – not for the first time, of course.

Probably, “a sober assessment of their policies over the last few years” will have to start with the radical possibility that central bankers have very little control over inflation – in either direction. The only known case of successful inflation management was by Paul
Volcker but achieved at the cost of two recessions in quick order. That central bankers were made responsible for inflation was a consequence of the monetarist theory of inflation of Milton Friedman.

It is only a theory and not THE THEORY. What if inflation was more likely caused by real factors than by monetary factors?

Perhaps, central bankers are effective in managing inflation only in the presence of certain enabling conditions and that those conditions are ignored in the assessment and evaluation of their effectiveness and the credit is mistakenly attributed to central bankers.

Another article that appeared in ‘Project Syndicate’ by Jason Furman is very realistic even though it is directed at political leaders. But, it very much applies to central bankers too:

In fact, the solution to our political problems, in 2018 and beyond, may lie not in any new policies or materially changed circumstances, but in finding better ways to communicate about the challenges we face, the efforts being made to address them, and the inherent limits that confront all policymakers. There has to be a better answer than just lying to people about what our policies are capable of accomplishing. [Link]

I like the emphasis on challenges, limitations, etc. That is the best start to solving problems.

So, the origins of a review of central banks’ policies lie elsewhere – in humility!

Thus, the review of central banks’ effectiveness has to be so radical that it won’t happen voluntarily at all!!

Jaggi goes for the jugular

Jaggi’s piece in Swarajya on the Monetary Policy Committee of the Reserve Bank of India contrasts with the Edit in MINT on RBI.

To an extent, strictly going by these two pieces, Jaggi’s piece struck a better chord than the MINT Edit.

Of course, I still believe that too much is made of India’s real rates. That diverts attention from the many failures of omission and commission on the part of elected governments.

Plus, I am a sucker for ‘tough love’ in micro or  macro matters. Examples abound:

  • Volcker with monetary policy in the USA from 1979 to 1981
  • Germany and Japan with their appreciating currencies and export growth built on productivity and quality
  • Rangarajan’s high real rates in 95-97 that ‘persuaded’ Indian corporations to de-leverage between 1998 and 2001 and be ready and hungry for re-leveraging and unleashing a capex cycle since 2002 (it turned excessive later)
  • Hong Kong’s real estate cycle deflation after the Asian crisis that lasted nearly a decade
  • Singapore’s approach to the real estate bubble since 2013, up to now

On balance, MINT Edit came across as a ‘gratuitous’ praise. Not wholly disproportionate but partially.

In other words, I am not sure RBI has done enough to deserve this praise. It may well, down the road. But, for now, it struck me as early days.

The dreaded ‘C’ word

Although asset valuations are high by historical standards, overall vulnerabilities in the financial sector appear moderate, as the banking system is well capitalized and broad measures of leverage and credit growth remain contained. [Link]

Ms. Janet Yellen, the soon-to-be-former Federal Reserve Chairperson, delivered a brief speech to the Joint Economic Committee of the U.S. Congress. The above sentence is an extract. She had used the now infamous ‘contained’ word. Ben Bernanke famously said that the housing bubble was contained.

I think it makes sense for those who follow central banks to follow the blog of MarkGB.