By Bilal Hafeez 19-09-2019
In: top-picks, Other

Top Picks: Monetary Policy & Inflation


3rd December

The ECB after the Crisis (ECB Working Papers) The ECB makes the case that its expanded responsibility to ensure the stability of the banking system, through the establishment of the Single Supervisory Mechanism (SSM), is the most far reaching action taken by the Euro-area. They argue that they can keep monetary policy and supervisory roles separate. [Bullish EU Financials]

Generation War on Inflation: Optimal Inflation Rates for the Young and the Old (Dallas Fed) Dallas Fed computes the optimal inflation rates for the young and the old in Japan. They conclude that the “optimal” rate for the older generation is negative due to their nominal asset holdings. An ageing population may lead to lower expected inflation rates in the long term. [Bullish JGBs]

26th November

There’s still a raging debate as to whether QE has inflated asset prices or whether policymakers should care about international developments. This week, we have pieces arguing ‘no’ in both cases.

A Tale of Two Financial Cycles: Domestic and Global (Bank of International Settlement) Big macro thinker Claudio Borio distinguishes between a domestic cycle (local fundamentals-driven, mainly affects property and credit ) and a global cycle (US monetary policy-driven, affects cross-border equity and bonds flows). He believes policymakers should focus on the domestic cycle, not the global cycle. [Bearish bonds]

Are Central Banks Manipulating Asset Prices? (Marginal Revolution) Argues that QE has driven asset prices – the average annual return of the Vanguard Total World Index is 8.9% on average over the period of QE which is in line with the 35-year average. [Bullish equities]

Notes from an Inter-planetary Monetary Anthropologist (Moneyness) JP Koning fantasies a planet “Zed” with a religious craze of setting a minimum interest rate of 2%  on deposits. With the planet’s economy slowing down, its inhabitants enter a debate to justify the need (or need not) for a lower interest rate.

Consumption, Credit, and the Missing Young (Boston Fed) The US now has a record number of young adults without sufficient credit history since the “CARD” Act was introduced in 2009. This portion of the population could drag down consumption growth on a state level. [Bearish US growth]


19th November

It’s clear that economists have got a lot wrong, but mainstream thinking isn’t changing much. Moreover, the Fed seems reluctant to try anything new when it comes to inflation targeting but is happy to support banks.

Against Economics – Book Review of “Money and Government: The Past and Future of Economics” (The New York Book Review) David Graeber argues that the mainstream economic thinking and policy is broken yet continues to be used. [Bearish economists!]

Learning and Misperception: Implications for Price-Level Targeting (Fed Board of Gov) Fed argues against adopting a temporary price-level targeting strategies during a recession. [Bearish rates]

The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges (Fed Board of Gov) Fed argues that they may have overestimated how high real rates should be as they didn’t correctly incorporate global trends. [Bullish rates]

Fed’s Push into Funding Markets Stirs Fears of Widening Role (Politico) Questions whether the FED’s latest effort to intervene in the funding market can lead to the Fed becoming the whole U.S. money market. The expectations that the FED will protect banks in volatile markets that are inconvenient to monetary policy, can potentially lead to adverse risk-taking by the banks. [Bullish banks]

12th November

Amidst Australia battling with catastrophic bushfires, the San Fran Fed is waking up to the need to tailor monetary policy to climate change and natural disasters. In Europe, the efforts to save the staling economy – and the euro – are surging.

A Phillips Curve for the Euro Area (Ball, Mazumder) Finds that the textbook Philips Curve largely holds for the Euro area, using a weighted median rather than core inflation rate, which includes food and energy prices.

Why Climate Change Matters for Monetary Policy and Financial Stability (Federal Reserve) After the Kincade fire in California destroyed homes and businesses alike and the ongoing Australian bushfires, monetary policymakers are waking up to the need for incorporating how disasters such as hurricanes, wildfires, and flooding affect labor markets, spending and output. [Bullish rates]

A Digital Euro to Save EMU (VOX EU) Thomas Mayer argues for the idea of relaunching the Euro as a digital bank central currency, suggesting it may be beneficial for the Eurozone economy in the long run and increase its competitive advantage on a global scale. [Bullish euro]

2nd November

Yesterday, the Fed cut rates for the third time this year. The persistent low rate environment seems to be a cause of bubbles forming after all. The least central bankers can do is help reduce carbon emissions – ‘Green QE’ is all in.

When Yields Talk, Sectors Listen (Advisor Perspectives) Low interest rates impact not only bonds but equity valuations too. And some sectors are more rate sensitive. Financials suffer whereas Utilities, Consumer Staples, and Healthcare outperform. [Bullish these latter sectors]

Herd Behaviour in Asset Markets: The Role of Monetary Policy(VOX) Argues against economist Robert Shiller’s findings that bubbles are random and unpredictable and instead finds they are closely linked to loose monetary policy. [Bearish stocks]

Jens Weidmann: Climate Change and Central Banks(Jens Weidmann)Discusses ways in which central banks can be involved in transitioning to a low-carbon economy. Heavy focus on green finance or ‘Green QE’, however, might distract from the main policy objectives and hinder bank independence. [Bearish green bonds]

26th October

With a few new Central Bankers settling in, and the UK about to select its new Governor, the uncertainty around their next move remains. Earlier this week we discussed the few specific ways to make QE work, given it now seems inevitable – now we look at how politics might play with fiscal stimulus. We also feature a great analysis on why the Philips curve is still relevant and why the Fed should do all it takes to foster expansion.

Can Tariffs Have a Deflationary Impact? (The Library of Economics and Liberty) Not all tariffs are inflationary. Famously, the Depression-era Smoot-Hawley tariff reduced aggregate demand by enough to offset any inflationary impact. It contributed to causing the Great Depression. Bearish growth and equities.

Objectives and Boundaries of Monetary Policy: A Governor to Renew the Bank of England’s Monetary Vows (VOX) Warns thatthe credibility of central banks gained after decades of hard work could be unwound by a new era of economic populism. This could be accelerated by central banks issuing short-term debt to help the governments fund their spending sprees. Suggests yield curve steepening.

The Phillips Curve: Dead or Alive (VOX) Argues that the Philips curve, which links employment to inflation, is not dead as many believe but just in hibernation. It will wake up – this has happened before in the 1960s  and history could repeat. Recommends the Fed’s to keep the economic expansion going, especially as unemployment could fall below natural rate estimates. Bulish rate markets.

19th October

Negative interest rates might be actually a good thing after all. Recent work by San Fran Fed shows they have stimulated economies.

The Cash Hoarding Puzzle and the Rising Global Demand for Cash (VOX) Demand for cash has been rising, despite the increased access to cashless payments.Finds monetary easing and aging population as main incentives for cash hoarding.

The Ownership of Central Banks (Bank Underground) Looks at the impact of public vs private ownership of Central Banks globally and finds that it makes little difference if the overarching aims are clear. Most, such as the BoE are wholly owned by the public sector, but in the US, Japan and Switzerland, there is a private shareholding.

Yield Curve Responses to Introducing Negative Policy Rates (San Francisco Fed) Studies the experience of five countries that introduced negative interest rates to see their impact on the economy. Finds that negative rates are effective in lowering yields of all maturities and effectively shifts the whole yield curve downwards, offering effective stimulus.

12th October

Worries are emerging around the nearing end of the cycle – and the possibility that the usual tools won’t work to revive it. More and more academic work is exploring unconventional policy and offers some comfort that it’s likely to work while policy-makers keep pushing for more easing.

Former Fed Chair Janet Yellen on Why the Answer to the Inflation Puzzle Matters (Brookings) Janet Yellen explains persistent low inflation and a flattened Philips Curve. She sees plenty of room for stimulating the economy and stoking wage gains without significant inflation.

Emergency Liquidity Injections (Reserve Bank of Australia) Compares the effectiveness of different methods of emergency liquidity injections in the banking system. Secured lending via repo seems best since it curbs fire sales and reduces incentive for liquidity risk-taking. Asset purchases aren’t as effective since banks aren’t required to commit future income as collateral.

Unconventional Monetary Policy Tools: A Cross-Country Analysis (BIS) Offers evidence that supports the use of unconventional monetary policy (negative rates, asset purchase programmes, forward guidance) in dealing with a downturn. Side effects such as overdependence on Central Bank funding and compressed rate margins are likely.

4th October

Everyone is worried about the structural challenges facing the Eurozone – it might be the eventual loser from the trade war. The US continues to face the “reserve currency curse” – the trade war could just be a mechanism to lose such status. It might just prove best to be a small economy, steer away from controversy and enjoy control over your policymaking.

Mario Draghi: Stabilisation Policies in a Monetary Union (BIS) Mario Draghi discusses whether the eurozone has increased its ability to stabilise macroeconomic shocks given that crisis has lasted in the region much longer than in other developed regions. The key matters are stabilisation across countries and stabilisation over the cycle.

Are Europe’s Economic Prospects Brighter Than They Appear?(Project Syndicate) Europe is the real loser from the US-China trade wars. The region is still extremely vulnerable to collateral damage, it always has the wrong policy response and is torn by internal political shocks (think Italy). Long-term prospects are brighter, however, driven by aggressive easing.

Nixon Shock, the Reserve Currency Curse, and a Pending Dollar Crisis(Mish Talk) The trade wars are just a hidden mechanism for the US to get rid of the “reserve currency curse”. No one seems to want to hold the World’s reserve currency and are working hard to ensure it stays that way. The EU and Japan have negative rates, China does not float the Yuan but props up corrupt SOEs, and Germany punishes the rest of the EU.

The Curse of Size (Econlib) Size matters – smaller countries have the choice to devalue their currency or go into negative rate territory without much attention and are free to control inflation. Argues that he creation of the euro made the world more susceptible to deflationary traps.

Unconventional Monetary Policy Operations: The Upside for Central Bank Balance Sheet Risks (Orduna, Schwaab) Finds that in exceptional circumstances, a central bank can remove illiquidity-related credit risk from parts of its balance sheet by extending the scale of its operations.

28th September

Threats to Central Bank Independence: High-Frequency Identification with Twitter (Bianchi, Kung, Kind) Academic paper finds that Trump tweets demanding the Fed cut rates does impact market pricing. Cumulatively, his tweets have lowered market expectations of Fed policy rate by 10bps.

Consumers Price Beliefs, Central Bank Communication, and Inflation Dynamics (Bank of Japan) Argues that prolonged periods of low inflation make the central bank’s inflation target less relevant for consumers. Instead, targeting price level (rather than the change in prices – inflation) would have more impact.

Credit Easing Versus Quantitative Easing: Evidence from Corporate and Government Bond Purchase Programs (Bank of England) BoE finds that buying corporate bonds was more effective than QE in reducing credit spreads, especially for higher-rated bonds.

Zero Lower Bound Risk according to Option Prices (San Fran Fed) Fed uses option prices and finds market has 24% probability that Fed policy rates will hit lower bound by end-2021.

New Weapons for the ECB (Project Syndicate) Former Greek finance minister, Yanis Varoufakis, argues that the ECB’s current toolkit will only lead to further right-wing populism as economic stagnation continues. Instead, he argues for the creation of “ECB conversion bonds” which effectively converts up to 60% of a country’s debt to low yielding bonds at ECB rates. This would allow for fiscal stimulus. Instead, he argues for the creation of “ECB conversion bonds” which effectively converts up to 60% of a country’s debt to low yielding bonds at ECB rates. This would allow for fiscal stimulus.

20th September

There’s so much criticism of monetary policy these days – much of it justified. One of the toughest criticisms is that it is leading to more monopolies. Aside from this, there is a role for more macro-pru policy and changes in the goals of policy.

Jerome Powell’s Dilemma (Project Syndicate) Top economists Carmen and Vincent argue that Powell is helping Trump get re-elected by neutralising the negative impacts of Trump’s trade policy.

Macroprudential Policy Could Have Reduced Imbalances in The Euro Area (VOX) Academics argue that country-specific macropru policy, such as adjusting LTV values for mortgages, are more affective in reducing Euro imbalances rather than ECB policy.

Could Ultra-Low Interest Rates Be Contractionary? (Project Syndicate) House of Debt authors Mian and Sufi and Princeton Prof Ernest Liu argue that big companies disportionately benefit from low rates and drive out competition. This reduces productivity and growth.

Hitting the Elusive Inflation Target (Chicago Fed) Argues that part of US’ inflation undershoot has been due to its symmetric inflation target. Allowing inflation overshoots is instead a better approach.

13th September

What Happens if Trump Tries to Fire Fed Chair Jerome Powell? (Brookings) It’s a bit more complicated than you think. Essentially, Trump would need cause (“inefficiency, neglect of duty, or malfeasance in office.) to remove him. Powell could sue if he felt it was unfair.

Did Dudley Do Right? (Project Syndicate) Prof Barry Eichengreen makes the case for the Fed and other central banks to make public their concerns about the policies of the government.

SNB – Between A Rock and a Hard Place (Pictet) Argues for more Swiss FX intervention to keep CHF weak, rather than rate cuts.

6th September

Central Banking’s Bankrupt Narrative (Project Syndicate, 4 min read) Prof Roger Farmer argues that aside from monetary policy not working, fiscal policy will also be ineffective. Instead, he argues that recessions are caused by asset market crashes and so policy should focus on that.

Estimating the economic impact of a wealth tax (Brookings, 3 min read) Makes the case for a wealth tax on the top 0.1% of Americans (see chart). Argues that it is more likely to work compared to other attempts in Europe which had a broader target. This is gathering support from various Democrat Presidential candidate.

Negative Interest Rates and Inflation Expectations in Japan (San Fran Fed, 8 min read) They find that inflation expectations actually fell after the BoJ introduced negative rates in 2016. They warn against cutting rates below zero.

Do Monetary Policy Announcements Shift Household Expectations? (Dallas Fed, working paper) They find Fed policy rate move surprises DO impact households’ economic confidence, but surprises on forward guidance and QE DO NOT. This questions the efficacy of unconventional policy.

ECB corporate QE and the loan supply to bank-dependent firms (ECB, working paper) – The central bank finds that corporate QE did increase bank lending. This suggests the ECB will restart such programmes soon.