Thank you very much for many intriguing insights!
It's you that got me thinking... thank you.
In light of a trial liquidity withdrawal of BoJ in the pass few months, both FRB and BoJ, probably along with BoE, found out that that is not an option in the current economic affairs.
I don't think the BoJ knew what it was doing. Economists today think very little on money supply. They think it all comes down to interest rates. See attached debate.
It is commonly believed that there is no limit for inflating, although it is apparent to everybody that leads to death of the existence. Why they tried the withdrawal tells me that they see the limit is already there. In other words, issuing more debt does not make any sense anymore hereon and on. Because a debt is an asset only if the debt raised capital could produce positive cash flow. That is not the case in FRB's and BoJ's actual feel. Thus, the limit is there.
IMO you are way too early here. Central bankers worldwide still believe the AD/AS model that "shows" that the only problem with monetary expansion is that it creates inflationary pressures in the medium term.
A new stage is impending upon us, more inflating is competitive devaluation of currencies. They are pondering on whether to do it or not since this will be the step to break all hell loose.
If you are referring to the central bank increasing the money supply and foreign currency reserves, again this has been tried by the BoJ with very little success.
If you think in terms of deflation as a decline in prices due to a contraction of the money supply it's not at all clear how could deflation be. This is what Bernanke was commenting about in the infamous helicopter drop speech. he can't understand how is deflation possible in the face of a determined increase of the money supply.
But deflation is possible strictly because it is not caused by a contraction of the money supply. Deflation is caused by risk aversion.
When the rain comes in (defaults rise) savers run to the arms of the state. If they can stay in the warm shelter (government bonds and the high real interest rate) they snuggle up together ( the bond bull market) and fall asleep until the weather improves (depression). They never try to fix the roof (fix the financial institutions that made the Mal-investment decisions in the first place). Even if you give them a free coat (increase the money supply) all they would do is they would make a nice pillow out of it and go back to sleep. Why should they fix the roof now if they can wait for the rain to stop?
Regards, YanivBA.
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Global: Debating the Liquidity Cycle (Part II)
Joachim Fels (London)
morganstanley.com
In yesterday’s GEF, the team debated the importance of a downturn in the global liquidity cycle for risky assets and the potential parallels between the current situation and the 1994 episode, when liquidity contracted as the Fed raised rates and the bond market crashed. The debate takes a different turn today.
David Miles (UK Economics) Joachim, I must say that I find the term ‘liquidity’ immensely confusing. Sometimes it appears to mean the level of interest rates; sometimes it appears to be about the scale of transactions in financial markets; sometimes it seems to be about the ability to sell in quantity at close to prices quoted on traders’ screens; sometimes it seems to be about credit restrictions (i.e., somebody’s inability to borrow at the level of interest rates banks set on loans). Can I make a plea that if we use the term we define exactly we mean?
Joachim Fels Good point. Many people are fuzzy about the term ‘liquidity’. But I thought I had defined it clearly when I described my chart. Global excess liquidity in my definition is the ratio of a narrow monetary aggregate like M1 to nominal GDP, for a broad group of countries. I chose a narrow aggregate rather than a broader one like M3 or credit, because this is most sensitive to the level of, and changes in, short-term interest rates. I view my measure of excess liquidity as a summary indicator for past and present monetary policy actions.
David Miles Understood. But as you well know the Fed and the Bank of England have massively downgraded their assessment of the usefulness of measures of the aggregate money supply, and to a somewhat lesser extent credit, as indicators of what is happening in the economy. This is not just a matter of whim or of intellectual fashion. It is a process that began at least 20 years ago. Empirical evidence of the statistical link between what is happening in the wider economy (to inflation, employment and output) and measures of money have consistently shown two things: first, that correlations (and no-one seriously thinks we are talking about causation here) are variable and unpredictable; second, that if you throw measures of money and credit into the mix with other information (e.g., surveys, movements in retail sales, interest rates and exchange rates and so on), they do not tend to have any consistent and reliable forecasting power. So on purely statistical grounds there is, I believe, a pretty clear message — don’t rely on shifts in measures of money to tell you too much reliable about what is going on in the economy.
But the reason that measures of money now play so much less of a role for policy makers in the US and the UK is not so much the empirical record. Far more important is the economics (that is the causal links) behind what is going on. In a nutshell it is this: if you focus on narrow money (M0 or M1), it is highly likely that movements in those aggregates reflect shifts in the technology of transactions — e.g., better and more ATMs, the existence of new types of credit cards and so on. There is also some correlation with spending — though there is unlikely to be much link between where spending might be over the next year or so (which is what matters for monetary policy) and shifts in yesterday’s stock of narrow money.
What about the economics of broad money? The problem here is that shifts in the private sector’s desire to hold a part of its total wealth in a subset of assets labelled ‘money’ (bank deposits of various sorts) are many and varied. To a large extent they reflect portfolio movements that are driven by shifts in the perceived attractiveness of a very wide range of assets. Quite what the interpretation of a shift in broad money for spending and inflationary pressures should be is absolutely unclear, until you drill down to what is driving it. Of course, once you drill down, you start asking questions about investment intentions, confidence indicators, consumer sentiment and so on. But if you need to measure and assess those factors to makes sense of a monetary aggregate, why bother looking at the monetary aggregate any more — focus instead on the indicators themselves, which are more directly linked to the pressures of spending and supply.
Joachim Fels None of this is controversial David, but my point is not about the ability of money or credit to explain what’s happening to spending, output or inflation. I merely claim that there is a link between the global stance of monetary policy, which I think is captured in my simple (and maybe simplistic) global excess liquidity measure, and asset prices. That link may not be precise, and it may be difficult to prove with rigorous statistical tools, but it seems to be there. And if we accept that (1) monetary policy affects asset prices and (2) asset prices affect the real economy, it follows that monetary policy affects the real economy via asset prices.
Stephen Roach Joachim, the turn — or lack thereof — in the global liquidity cycle is key for the financial market debate. We are all in agreement on that. The metrics that enable us to judge how and when are in serious dispute, however. As for the quantity story, my advice is to give up the ghost. Rather than looking at quantity measures of liquidity, I would prefer, instead, to focus on the price of liquidity — i.e., by focusing on real interest rates. On that basis, the Fed has turned the knob on the liquidity spigot — but the flow is still steady (i.e., neutral). It is still wide open in Japan and flowing with reasonable speed in Europe.
Richard Berner I agree 100% that the price of credit is the relevant metric. Now if we only knew what the right price is!
Joachim Fels I’d be the first to admit that quantity measures of liquidity are not the holy grail — they are just one (though, I think informative) indicator to gauge the policy stance and thus the impact on financial markets and the economy. That’s exactly why Manoj Pradhan and I have taken a very different approach — estimating the natural, or neutral, rate of interest using a neo-Keynesian framework that is very different from the monetarist-inspired quantity measure of liquidity. Comparing actual interest rates to the estimated natural rate probably comes closest to a ‘price’ measure for whether liquidity is abundant or scarce. And guess what? Our results for the US suggest that the Fed is already in restrictive territory, with the neutral rate in the 4.25-4.5% area, which would seem to fit in with the notion that global liquidity has become less plentiful.
Stephen Roach Joachim, you have made a noble effort at the short end of the US yield curve — what about the short end of other curves? What about the long end?
Joachim Fels Regarding long rates, when estimated properly, the measure of the natural rate also reflects the impact of long rates (and the exchange rate, and fiscal policy, etc) on the economy. The natural rate is the interest rate that keeps the economy growing at trend and inflation stable, taking into account all the other headwinds or tailwinds for the economy, such as high or low long-term interest rates.
Regarding the same analysis for other countries, our estimate of what we call the Nat-EUR-al rate of interest for the euro area suggests that the ECB refi rate is still some 50bp below the natural rate — so the ECB is still expansionary, though not much so. For Japan, we don’t have good estimates yet (this is work in progress), but it’s a fair guess that policy is expansionary at a policy rate of zero! I would warn against putting too much weight on any particular estimate of the natural rate, however. Like output gaps, this is a somewhat vague concept
Robert Feldman (Japan Economics) I would emphasise your latter point, Joachim. There are three sets of uncertainties here: (1) The quality of the underlying data, (2) the accuracy of the underlying model, and (3) the accuracy of the statistical techniques. Given these problems, it is only honest to give standard errors of estimate when making forecasts based on such models.
For example, the Bank of Japan is pounding the table about the output gap being back at zero. However, as I showed in my piece several weeks ago, ‘zero’ actually means ‘zero plus or minus 8 percentage points’ for a 95% confidence band.
Joachim Fels I agree with Robert. We show standard errors for our natural rate estimates and they are several percentage points wide. Like output gaps, they can be a treacherous concept. That’s exactly why I advocate looking at a variety of indicators for monetary policy stances or liquidity conditions, including (and I’m repeating myself now) quantity indicators. Talking about Japan, what should we make of the Bank of Japan’s draining of excess reserves in the money market? Some investors I have spoken to claim that this is one reason for the sell-off in risky assets since May. |
