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from: Erwan Mahé (guest post)

Do not speak, unless it improves on silence.” (Buddhist Sayings)

This Buddhist aphorism pretty much sums up the reason for the lack of a new Thaler’s Corner in more than thirty days, which, excluding the holiday periods, amounts to a first for me (the last being “Sad September”, on 3 September). At the time, I emphasised the danger of market indices falling back to the “Black Market” levels of last August 24th, like they did in the wake of the flash crash of May 2010. The idiosyncratic shocks triggered by the Volkswagen and then the Glencore scandals, the prolonged weakness of emerging markets and the Fed’s relentless caution initially seemed to suggest I was right, as the Euro Stoxx 50 dipped below 3,000 points at the end of September, i.e. nearly 10% below the level at the time of my last Thaler’s Corner.

But I am obliged to return to the drawing board, given the market’s behaviour since the release last Friday of the disappointing jobs figures in the United States, with about a 3% rebound in intraday indices Friday and the new surge of the Euro Stoxx 20 to 3,170, as I write these lines. As usual, in times of confusion, the most natural course of action is to fall back on time-tested indicators like our graphs measuring credit, inflation, and retail sales in Europe and the United States.

The Fed and its inflation target


We have been hearing a whole lot of noise, following the decision not to raise its benchmark rate at the last FOMC meeting in September, and the rising level of global uncertainties! But how can we not listen to the latest comments by the Minnesota Fed chief, Narayana Kocherlakota:

Given the inflation outlook, given how low inflation is expected to be, to ensure the credibility of our inflation target, taking a more accommodative stance in September would have been totally justified”.

The fact there was no vote this year, and that he is leaving the Fed in December, surely gives him more freedom to express himself, but, considering the Fed’s basic mandate (inflation stabilised at about an average of 2% and full employment), it is hard to disagree with him on the matter. That said, I view his idea of instituting negative interest rates in the States as counterproductive. As I have commented many times before, negative rates amount to monetary destruction. They are essentially a tax on the stock of money (the excess reserves), which is deflationist. I really do not see any way such a measure could re-boot inflation to meet the Fed’s target range, quite the contrary! I have (too) long argued that, when faced with a situation of persistent 0% lower bound, a central bank in need of beating back deflationist trends must rely on fiscal measures, as former Fed chief Ben Bernanke commented today in his severe critique of Herr Schäuble: How the Fed Saved the Economy.  Readers interested in the role-playing between fiscal and monetary authorities should also check out this article: And the Winner is (should be)…. Fiscal Policy!  (4 September) by Francesco Saraceno (OFCE).

Growth in the US

sg2015100534669 (2)

In the above graph, the yellow curve represents the changes in real estate prices in the United States. The green curve is an effort to determine a “real animal rate”, which takes into account, not only nominal mortgage rates but also the changes on the employment and real estate markets. These rates are still in negative territory, which is good for the real estate market, the sector of the US economy that could be decisive in determining the overheating potential. In this case, the long term rates are factored in, not the central bank’s benchmark rate! So my question is: If the Fed wants to pull back from its accommodative monetary policies, why not start by stopping the reinvestment of the coupons and principal from its QE? Such an approach would present a number of obvious advantages:

–          It would constitute the first step towards a real normalisation of the Fed’s monetary policies. It indeed established its QE programme in the face of 0% lower bound. It therefore seems logical to begin by reducing the amount of excess reserves thus created. It could then attack short-term rates, once its balance sheet has returned to a normal level.

–          Due to the presence of these excess reserves in the system, the Fed will have to activate its ONRPP programme (overnight repo) with financial counterparties in order to stop short-term rates from falling below its new benchmark rates when it decides to hike it. Here’s a text for the geeks: Excess Reserves and Monetary Policy Normalization.

–          By withdrawing these reserves while keeping its short-term rates at 0%, the Fed would influence the form of the rates curve by steepening it. This steepening would encourage long-term savings and therefore the purchasing power of investors concentrated on that segment (pension funds, insurers, etc.). This would bring a burst of fresh air to banking establishments, who could then return to their traditional “transformation-carry” activity.

–          To top it off, by demonstrating its ability to exit from its QE without racking up a nominal loss (the prices of its bonds are high while long-term rates are very low), it would effectively rebut the endless criticisms on this matter, which would provide it manoeuvring room, should it need to use these measures again.

–          If, despite everything, inflation were to become a threat in the years to come, it would still have plenty of time to hike its benchmark rates, which is the easiest thing to do for a central bank!

In order to obtain a broader view of price trends, I have updated our 5-year forward inflation expectation rates graph for the UK, the US and the eurozone.

The ECB and its inflation target


I continue to prefer this indicator over the 5-year/5-year forward inflation expectations cited by Mario Draghi, because I consider the latter maturity to be way too long and disconnected from a reality in which decisions are much more “short term”. I am not sure this graph needs explanation, as the curves speak for themselves. We can nonetheless point out that, after a brief resurgence following the ECB’s announcement of its QE programme, these inflation expectations wilted like a dried flower. Today they are well below the target of 2%. This may also give us an idea of how long the ECB will keeps its rates very low, which explains why the 5-year German rates (Bobl) has returned to marginally negative territory, in order to avoid the compounding of interest at -0.25%. The fact that the 2-year German rate is trading below -0.25% (ECB deposit rate) suggests that a probability may already be priced in that this rate will be lowered further into negative territory in the future.

Fiscal policy must also pick up the slack from monetary policy here, if we truly want to want to avoid remaining at 0% lower bound forever! That’s will be it for today. I realise that all this does not explain why the indices have just climbed 5%, from their lows of last Friday, and it does not help us guess whether this shift will end abruptly or continue. So I will take the advice from own introduction: “Do not speak, unless it improves on silence.

The Macro Geeks’ Corner (MG)

Are reserves still “special”?

Matthew Osborne and Mathew Sim. Bank Underground, BOE. 28 September 2015


How low can you go?

Andrew G Haldane, Chief Economist, Bank of England, 18 September 2015

Some Perhaps Cogent Thoughts on the Structure of the Fed, on Productivity Trends, and on Macroeconomic Policy

Brad Delong, 18 September 2015

What Is Money And How Is It Created?

Steve Keen, Forbes, 28/02/2015

Banks are Not Intermediaries of Loanable Funds – And Why This Matters
Zoltan Jakab & Michael Kumhof (IMF);  BOE, 29 May 2015.

Keynes’s ‘beauty contest’

Richard H. Thaler, September 02, 2015

Monetary financing and refugees

Christian Odendahl, CER, 18 September 2015

Complicit in Corruption: How German Companies Bribed Their Way to Greek Deals

Jorg Schmitt, Spiegel, 11 May 2010




  1. BC
    October 6, 2015 at 5:10 pm

    The Fed will never reduce its holdings. See the precedent of the 1930s-50s and the gold monetary reserve holdings in the 1890s-1900s.

    The TBTE banks’ shadow banks’ offshore pass-through entities’ carry trade is levered 50-80:1 vs. 25-30:1 in 2006-08 prior to the implosions of Bear Stearns, Lehman, and AIG. The Fed raising the reserve rate risks blowing out the term structure for the hopelessly levered global carry trade. A loss of banking system capital of as little as 1.25-2% that persists is sufficient to blow up the system again, only this time worse than in 2008-10.

    The next recession and equity and corporate bond bull markets will again result in $1 trillion US deficits and the Fed being required to increase the monetary base/reserves by trillions of dollars more to liquefy TBTE banks’ balance sheets in order to provide the liquidity for the primary dealer TBTE banks to fund the deficit to prevent nominal GDP from contracting.

    See Japan’s precedent since the late 1990s. The monetary base will eventually reach parity with the assets of the largest banks, keeping the multiplier and velocity pegged to the floor, and effectively precluding fractional reserve banking at ZIRP and NIRP.

    The larger the total debt and unfunded liabilities that will be required to be funded via deficit spending in the future, the less likely the Fed can “normalize” rates with the post-2007 trend nominal and real GDP per capita rates below 2% and at ~0% respectively.

    Secular stagnation, debt-deflationary regime, and Limits to Growth. There is no way out save for debt/asset deflation as a share of wages and GDP and an increase in labor share for the bottom 90%.

  2. BC
    October 6, 2015 at 7:47 pm

    Correction: “The next recession and equity and corporate bond BEAR markets . . . “

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