Karim writes:
No outliers.
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This is the exact same line Niall Ferguson is spewing.
He also says the two choices are inflating or defaulting.
The inflation would be from too much aggregate demand and a too small output gap.
That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.
Sounds like that’s the goal of deficit spending to me- so in faccct he’s saying deficit spending works with his rant on why it doesn’t.
And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders.
Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered.
In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990’s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happend shortly after y2k.
Feel free to pass this along to either.
The fiscal black hole in the US
June 12 (FT)—US budgetary prospects are dire, disastrous even. Without a major permanent fiscal tightening, starting as soon as cyclical considerations permit, and preferably sooner, the country is headed straight for a build up of public debt that will either have to be inflated away or that will be ‘resolved’ through sovereign default.
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(email exchange)
The latest noise is that today’s deficits mean higher taxes later.
Answer:
1. Taxes function to reduce aggregate demand.
2. A tax hike is never in order with a weak economy, no matter how high the deficit or how high the interest payments may be.
3. Future tax increases would be a consideration should demand rise to the point where unemployment fell ‘too far’- maybe below 4%.
4. That is a scenario of prosperity and an economy growing so fast that it might be causing inflation which might need a tax hike or spending cut to cool it down.
So when someone states that today’s high deficit mean higher taxes later, he is in fact saying that today’s high deficits might cause the economy to grow so fast that it will require tax increases or spending cuts to slow it down.
Sounds like a good thing to me — who can be against that?
And, of course, the government always has the option to tax interest income if interest on the debt is deemed a problem at that time.
> On Fri, Jun 12, 2009 at 8:46 AM, James Galbraith wrote:
>
> A comment in the National Journal, on the ever-green deficit alarmism that so preoccupies
> people in Washington, to no good effect.
>
> Also, my June 5 lecture in Dublin, at the Institute for International and European Affairs, on the
> crisis.
>
> With Q&A
>
> And a small postscript, reprising the old story of Eliza in Cuba, which I’ve promised her I
> will now retire
>
> Jamie
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What Is Fiscally — And Politically — ‘Sustainable’?
By James K. Galbraith
Professor of Economics, University of Texas
June 11th —Chairman Bernanke may, if he likes, try to define “fiscal sustainability” as a stable ratio of public debt to GDP. But this is, of course, nonsense. It is Ben Bernanke as Humpty-Dumpty, straight from Lewis Carroll, announcing that words mean whatever he chooses them to mean.
Now, we may admit that the power of the Chairman of the Board of Governors of the Federal Reserve System is very great. But would someone please point out to me, the section of the Federal Reserve Act, wherein that functionary is empowered to define phrases just as he likes?
A stable ratio of federal debt to GDP may or may not be the right policy objective. But it is neither more nor less “sustainable,” under different economic conditions, than a rising or a falling ratio.
In World War II, from 1940 through 1945, the ratio of US federal debt to GDP rose to about 125 percent. Was this unsustainable? Evidently not. The country won the war, and went on to 30 years of prosperity, during which the debt/GDP ratio gradually fell. Then, beginning in the early 1980s, the ratio started rising again, peaked around 1993, and fell once more.
Thus, a stable ratio of debt to GDP is not a normal feature of modern history. Gradual drift in one direction or the other is normal. There seems no great reason to fear drift in one direction or the other, so long as it is appropriate to the underlying economic conditions.
History has a second lesson. In a crisis, the ratio of public debt to GDP must rise. Why? Because a crisis – and this really is by definition – is a national emergency, and national emergencies demand government action. That was true of the Great Depression, true of war, and true of the Great Crisis we’re now in. Moreover, we’ve designed the system to do much of this work automatically. As income falls and unemployment rises, we have an automatic system of progressive taxation and relief, which generates large budget deficits and rising deficits. Hooray! This is precisely what puts dollars in the pockets of households and private businesses, and stabilizes the economy. Then, when the private economy recovers, the same mechanisms go to work in the opposite direction.
For this reason, a sharp rise in the ratio of debt to GDP, reflecting the strong fiscal response to the crisis, was necessary, desirable, and a good thing. It is not a hidden evil. It is not a secret shame, or even an embarrassment. It does not need to be reversed in the near or even the medium term. If and as the private economy recovers, the ratio will begin again to drift down. And if the private economy does not recover, we will have much bigger problems to worry about, than the debt-to-GDP ratio.
It is therefore a big mistake to argue that the next thing the administration and Congress should do, is focus on stabilizing the debt-to- GDP ratio or bringing it back to some “desired” value. Instead, the ratio should go to whatever value is consistent with a policy of economic recovery and a return to high employment. The primary test of the policy is not what happens to the debt ratio, but what happens to the economy.
*****
Now, what about those frightening budget projections? My friend Bob Reischauer has a scary scenario, in which a very high public-debt-to-GDP ratio leaves the US vulnerable to “pressure from foreign creditors” – a euphemism, one presumes, for the very scary Chinese. Under that pressure, interest rates rise, and interest payments crowd out other spending, forcing draconian cuts down the line. To avert this, Bob has persuaded himself that cuts are required now, not less draconian but implemented gradually. Thus the frog should be cooked bit by bit, to avoid an unpleasant scene later on when the water is really boiling hot.
With due respect, Bob’s argument displays a very vague view of monetary operations and the determination of interest rates. The reality is in front of our noses: Ben Bernanke sets whatever short term interest rate he likes. And Treasury can and does issue whatever short-term securities it likes at a rate pretty close to Bernanke’s fed funds rate. If the Treasury doesn’t like the long term rate, it doesn’t need to issue long-term securities: it can always fund itself at very close to whatever short rate Ben Bernanke chooses to set.
The Chinese can do nothing about this. If they choose not to renew their T-bills as they mature, what does the Federal Reserve do? It debits the securities account, and credits the reserve account! This is like moving funds from a savings account to a checking account. Pretty soon, a Beijing bureaucrat will have to answer why he isn’t earning the tiny bit of extra interest available on the T-bills. End of story.
The only thing the scary foreign creditors can do, if they really do not like the returns available from the US, is sell their dollar assets for some other currency. This will cause a decline in the dollar, some rise in US inflation, and an improvement in our exports. (It will also cause shrieks of pain from European exporters, who will urge their central bank to buy the dollars that the foreigners choose to sell.) The rise in inflation will bring up nominal GDP relative to the debt, and lower the debt-to-GDP ratio. Thus, the crowding-out scenario Bob sketches will not occur.
I’m not particularly in favor of this outcome. But unlike Bob Reischauer’s scenario, this one could possibly occur. And if it did, it would lower real living standards across the board. This is unpleasant, but it would be much fairer than focusing preemptive cuts on the low-income and vulnerable elderly, as those who keep talking about Social Security and Medicare would do.
****
Now, it is true, of course, that you can run a model in which some part of the budget – say, health care – is projected to grow more rapidly than GDP for, say, 50 years, thus blowing itself up to some fantastic proportion of total income and blowing the public finances to smithereens. But this ignores Stein’s Law, which states that when a trend cannot continue it will stop, and Galbraith’s Corollary, which states that when something is impossible, it will not happen.
Why can’t health care rise to 50 percent of GDP? Because, obviously, such a cost inflation would show up in – the inflation statistics! – which are part of GDP. So the assumption of gross, uncontrolled inflation in health care costs contradicts the assumption of stable nominal GDP growth. Again, the consequence of uncontrolled inflation is… inflation! And this increases GDP relative to the debt, so that the ratio of debt to GDP does not, in fact, explode as predicted.
I do not know why the CBO and OMB continue to issue blatantly inconsistent forecasts, but someone should ask them.
Further confusion in this area stems from treating Social Security alongside Medicare as part of some common “entitlement problem.” In reality, health care costs and haphazard health insurance coverage are genuine problems, and should be dealt with. Social Security is just a transfer program. It merely rearranges income. For this reason it cannot be inflationary; the only issue posed is whether the elderly population as a whole deserves to kept out of poverty, or not.
Paying the expenses of the elderly through a public insurance program has the enormous advantage of spreading the burden over all other citizens, whether they have living parents or not, and of ensuring that all the elderly are covered, whether they have living children or not. A public system is also low-cost and efficient, and this too is a big advantage. Apart from that, whether the identical revenue streams are passed through public or private budgets obviously has no implications whatever for the fiscal sustainability of the country as a whole.
****
What is politically sustainable is nothing more than what the political community agrees to at any given time. I have been surprised, and pleased, by the political community’s acquiescence in the working of the automatic stabilizers and expansion program so far. The deficits are bigger, and therefore more effective, than many economists thought would be tolerated. That’s a good sign. But it would be a tragedy if alarmist arguments now prevailed, grossly undermining job prospects for millions of the unemployed.
Let me note, in passing, that Chairman Bernanke should please read the Federal Reserve Act, and focus on the objectives actually specified in it, including “maximum employment, stable prices and moderate long-term interest rates.” He does not have a remit to add stable debt-to-GDP ratios or other transient academic ideas to the list. One might think that the embarrassing experience with inflation targeting would be enough to warn the Chairman against bringing too much of his academic baggage to the day job.
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Get Ready for Inflation and Higher Interest Rates
The unprecedented expansion of the money supply could make the ’70s look benign.
By Arthur B. Laffer
June 10th (WSJ)— Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be “wasted.” Crises enable vastly accelerated political agendas and initiatives scarcely conceivable under calmer circumstances. So it goes now.
Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That’s more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers’ expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.
Art knows the difference between purchasing financial assets (usually done by the Fed) and purchasing goods and services (and indirectly through transfer payments) but here elects to ignore it.
With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.
He also recognizes the demand leakages including pension fund contributions, insurance reserves, USD financial accumulations of non residents, IRA’s, other corporate reserves, etc. tend to compound geometrically and are thereby strong contractionary biases.
But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.
He also knows causation runs from loans to deposits and reserves and not from reserves to anything at all.
I’ve had this discussion personally with him and I wrote ‘soft currency economics’ jointly with Mark McNary who worked at art’s firm with both involved.
About eight months ago, starting in early September 2008, the Bernanke Fed did an abrupt about-face and radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.
Bank reserves are crucially important because they are the foundation upon which banks are able to expand their liabilities and thereby increase the quantity of money.
He knows this is not the case. He knows that lending is in no case reserve constrained, and that it’s about price and not quantity.
Banks are required to hold a certain fraction of their liabilities — demand deposits and other checkable deposits — in reserves held at the Fed or in vault cash. Prior to the huge increase in bank reserves, banks had been constrained from expanding loans by their reserve positions.
There were no banks of any consequence constrained from lending by their reserve positions that I know of.
In fact, they all had excess collateral they could have taken to the discount window as needed.
There were some banks constrained by capital considerations but that’s an entirely different story.
That’s why adding the excess reserves didn’t change anything with regards to lending.
Art knows this as well.
They weren’t able to inject liquidity into the economy, which had been so desperately needed in response to the liquidity crisis that began in 2007 and continued into 2008. But since last September, all of that has changed. Banks now have huge amounts of excess reserves, enabling them to make lots of net new loans.
Yet a chart of lending shows no changes as functions of reserve positions.
The way a bank or the banking system makes new loans is conceptually pretty simple. Banks find an entity that they believe to be credit-worthy that also wants a loan, and in exchange for the new company’s IOU (i.e., loan) the bank opens up a checking account for the customer. For the bank’s sake, the hope is that the interest paid by the borrower more than makes up for the cost and risk of the loan. The recently ballyhooed “stress tests” on banks are nothing more than checking how well a bank can weather differing levels of default risk.
Correct. And these loans are not reserve constrained.
And even if they were somehow constrained by reserves, innovations in sweep accounts have reduced reserve requirements to near 0.
What’s important for the overall economy, however, is how fast these loans are made and how rapidly the quantity of money increases.
Most important is the level of spending which may or may not be a function of the lending that creates the ‘quantity of money’ as defined by Art. And he knows that as well.
For our purposes, money is the sum total of all currency in circulation, bank demand deposits, other checkable deposits, and travelers checks (economists call this M1). When reserve constraints on banks are removed, it does take the banks time to make new loans. But given sufficient time, they will make enough new loans until they are once again reserve constrained.
He knows they are never reserve constrained.
The expansion of money, given an increase in the monetary base, is inevitable, and will ultimately result in higher inflation and interest rates. In shorter time frames, the expansion of money can also result in higher stock prices, a weaker currency, and increases in commodity prices such as oil and gold.
In general the causation runs in the other direction, as he also knows.
At present, banks are doing just what we would expect them to do. They are making new loans and increasing overall bank liabilities (i.e., money). The 12-month growth rate of M1 is now in the 15% range, and close to its highest level in the past half century.
He also knows a lot of this simply replaced commercial paper issuance and other forms of non bank lending, and that total credit is the more useful indicator of lending activity.
With an increased trust in the overall banking system, the panic demand for money has begun to and should continue to recede. The dramatic drop in output and employment in the U.S. economy will also reduce the demand for money. Reduced demand for money combined with rapid growth in money is a surefire recipe for inflation and higher interest rates. The higher interest rates themselves will also further reduce the demand for money, thereby exacerbating inflationary pressures. It’s a catch-22.
He also knows interest rates are voted on by the fed and that term rates reflect anticipated Fed moves.
It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S.
He knows there are no consequences. The Fed is like the kid in the car seat with a steering wheel who thinks he’s driving.
To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges. It wasn’t a pretty picture.
He knows that was caused by cost push from Saudi price setting that was broken by the deregulation of natural gas in 1978 that resulted in a 15 million barrel per day supply response as our utilities switched from oil to natural gas.
Now the Fed can, and I believe should, do what it must to mitigate the inevitable consequences of its unwarranted increase in the monetary base. It should contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion.
All that would do is raise rates some due to the fed selling its securities.
Or the Fed could repo its position so the banks would hold overnight collateral rather than over night reserves. Functionally that changes nothing except for creating a lot more book keeping work.
Absent this major contraction in the monetary base, the Fed should increase reserve requirements on member banks to absorb the excess reserves.
This is just plain silly.
Art knows there is no remaining ‘monetary purpose’ of reserves since we went off the gold standard, which he understands as well as anyone.
Canada and others dropped reserve requirements long ago with no consequences beyond a reduced accounting burden.
Given that banks are now paid interest on their reserves and short-term rates are very low, raising reserve requirements should not exact too much of a penalty on the banking system, and the long-term gains of the lessened inflation would many times over warrant whatever short-term costs there might be.
No penalty and no inflation consequences either.
Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury’s planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.
Yes, yields would go higher, though not as disorderly as he forecasts.
And, as previously discussed, there’s no reason to do that unless the fed wants higher rates.
In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession.
He knows the contraction of the base back then did not cause anything.
While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it’s a Hobson’s choice. For me the issue is how to protect assets for my grandchildren.
The best gift he could give his grand children is to tell the story right way around as he knows is the case.
Mr. Laffer is the chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy — If We Let It Happen” (Threshold, 2008).
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Yes, as previously discussed, announcing a term structure of Fed funds levels would be far more effective in bringing rates down than securities purchases.
But that closes the door to rate hikes for that period of time, which is exactly what markets discount with the current term rate structure.
Especially with crude and commodities going up and the dollar going down, as markets discount that at some point the Fed will react to that ‘imported inflation’ with rate hikes.
Meanwhile the current ‘mercantalist’ Fed is fine with a lower dollar hoping it will help the US export its way to trend GDP growth rather than get there by domestic debt and consumption. Or at least reduce the marginal propensity to import that they fear could drain demand and abort the recovery. Unfortunately the preference for exports over domestic consumption translates to a lower standard of living via a reduction in real terms of trade.
That’s what was happening last year about this time when the great Mike Masters inventory liquidation hit and it all went bad. This time around there isn’t any excess inventory to break prices and cap utilization/employment is way down and still falling some, and rest of world economies appear too weak to absorb substantial US exports.
And the Saudis are back in control of crude prices after a very surprisingly small fall in world consumption given the size and scope of the international slowdown.
BoE’s Barker says rates could stay low for “quite some time”
MPC member Kate Barker told the Leicester Mercury newspaper that there
remained question marks over the sustainability of the recovery and that
interest rates “could stay low for quite some time”. Ms Barker echoed
Paul Tucker’s comments yesterday in saying that it would take some
months yet for the MPC to judge how robust the turnaround in activity
was: “The really important question is (whether) there’s a pick up in
the economy and if people can sustain that so it continues on to autumn.
That would be one of the most encouraging signs,” she said.
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The ECB remains way ahead of the fed regarding monetary operations.
It has been setting rates and letting quantity adjust and now addresses
unfounded concerns of ‘exit strategies’ head on.
(I take issue only to the extent of the potential inflationary implications and influence on growth and employment of interest rate policy in general, but that’s another story.)
The covered bond purchase could have utilized a rate target rather than a quantity target but their policy might not be to target a specific rate.
Also note they accept collateral down to a bbb rating from their member banks, which is includes bank paper and is functionally very close to unsecured lending- a policy that i have been suggesting would have served the fed well from the beginning of the crisis.
Trichet Sees Automatic Exit From ECB’s Non-Standard Measures
June 5 (Bloomberg) — European Central Bank President Jean- Claude Trichet said banks will seek less credit from the ECB when the economy improves, automatically reducing the amount of money in the system and ensuring a non-inflationary recovery.
By concentrating its non-standard policy measures on the supply of unlimited liquidity to banks, the ECB has ensured it has “an in-built exit strategy,†Trichet said in a speech in Warsaw today. “That is, when tensions in financial markets ease, banks will automatically seek less credit from the ECB.
This will be a decisive element in ensuring a non-inflationary recovery.â€
The Frankfurt-based ECB, which has cut its benchmark interest rate to a record low of 1 percent, has said it will loan banks as much money as they need for up to 12 months and pledged to buy 60 billion euros ($85 billion) of covered bonds in an effort to revive lending. The ECB yesterday lowered its economic forecasts for this year and next. It now expects the economy of the 16 nations using the euro to shrink by about 4.6 percent this year before returning to positive quarterly growth rates by mid-2010.
“Once the macroeconomic environment improves, the Governing Council will ensure that the measures taken can be quickly unwound and the liquidity provided absorbed,†Trichet said. “Hence, any threat to price stability over the medium and longer term will be effectively countered in a timely fashion.â€
Merkel’s Warning
German Chancellor Angela Merkel on June 2 scolded the Federal Reserve and Bank of England for pumping too much money into their economies and said that by deciding to buy covered bonds, the ECB had “bowed somewhat to international pressure.â€
She urged a return to a “policy of reason.â€
Trichet said the ECB’s “bold yet solidly-anchored response†to the worst economic crisis since World War II is “encouraging.†While long-term inflation expectations remain anchored around the ECB’s 2 percent limit, “our measures show some signs of revival in the functioning of money markets in Europe,†he said.
Trichet added that the crisis has not altered the ECB’s primary objective of maintaining price stability. “This objective will always provide the context and limits within which our course of action is framed and enacted.â€
Trichet Says ECB Will Buy Covered Bonds Next Month
by Neil Unmack
June 4 (Bloomberg) — The European Central Bank will start buying 60 billion euros ($85 billion) of three- to 10-year covered bonds from July, President Jean-Claude Trichet said.The central bank will buy bonds rated at least BBB- in the primary and secondary markets until June 2010, but doesn’t plan to purchase other assets, the ECB said after policy makers held interest rates at a record-low 1 percent. The ECB said on May 7 it will buy covered bonds in a bid to revive the market, which lenders use to finance mortgages and public-sector loans.
Covered bond issuance increased after the ECB announced the purchase program last month, with banks selling 26.8 billion euros of the debt, according to data compiled by Bloomberg. The $2.8 trillion market had been roiled by the credit crisis, and sales had halved to 48.6 billion euros by May 7, compared with 99.4 billion euros in the same period a year earlier.
“It’s supportive for the primary and secondary covered bond market,†said Leef Dierks, a credit analyst at Barclays Capital in Frankfurt. “We expect the issuance window to remain open, and believe that the positive momentum in the secondary market will continue.â€
To be included in the ECB’s purchase plan, covered bonds “must be eligible for use as collateral in the euro system’s credit operations,†Trichet said. The bonds must “have as a rule a volume of about 500 million euros or more and in any case not lower than 100 million euros,†he said.
Bond Eligibility
Bonds bought by the central bank must comply with the so- called UCITS directive, a European regulatory framework for mutual funds, or have “similar safeguards,†Trichet said, without being more specific.
“They want to get the most bang for their euro, and that means helping the bonds that will have the widest investor support in the market,†said Ted Lord, head of covered bonds at Barclays.
The ECB said it will buy bonds through “direct purchases†rather than following the Bank of England’s example of using auctions.
“We would like more clarity on how these direct purchases will work,†said Heiko Langer, a covered bond analyst at BNP Paribas SA in London. “Will we know how much they have bought, what they have bought, and at what price?â€
Regarding the euro region’s economy, Trichet said confidence may improve more quickly than has been forecast.
“Risks to the economic outlook are balanced,†he said. “On the positive side†there are “stronger-than-anticipated effects from stimulus measures underway and other policy measures taken. Annual inflation rates are projected to decline further and become negative over the coming months.â€
Covered bonds are backed by real-estate or public-sector debt and tend to have a higher rating than straight corporate bonds because they’re also supported by a borrower’s pledge to pay.
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Interesting focus on FX from both ECB and BOC this morning:
From BOC:
–In recent weeks, financial conditions and commodity prices have improved significantly, and consumer and business confidence
have recovered modestly. If the unprecedentedly rapid rise in the Canadian dollar (which reflects a combination of higher
commodity prices and generalized weakness in the U.S. currency) proves persistent, it could fully offset these positive factors.
–Key is term ‘unprecedented’ and that rise in C$ is not fully explained by the rise in commodity prices.
From ECB:
–ECB staff updated its forecasts for growth and inflation. Main change was in 2009 growth forecast:
Now -4.1% to -5.1% from estimates of -2.2% to -3.2% in March
Trichet stated: “its very important u.s. repeats strong dollar policyâ€.
The Euro is not trading far from levels that Trichet described as ‘brutal’ in the past.
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Raise taxes with unemployment rising due to a shortage in aggregate demand?
Just in case you thought the great marketer understood the monetary system:
Pimco’s Gross: Maybe Obama Should RAISE Taxes
By: JeeYeon Park
June 3 (CNBC) — Inflation is likely three to five years down the road, and investors should stay relatively close to the front end of the yield curve where the bond prices are protected by the Fed position of low Fed funds and interest rates, said Bill Gross, co-CIO and founder of Pimco.
“Further out on the curve, anticipate deterioration in inflation, a deterioration possibility in terms of the dollar, which will produce negative returns for those long-dated securities,†Gross told CNBC.
Gross said the recovery is being driven by a $2 trillion annualized deficit. To take its place in the economy would require at least $1 trillion increase in consumption and investment, which would be quite challenging as baby boomers and consumers become more thrifty.
He also said the Obama administration should cut back on inefficient defense programs — and consider raising taxes.
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> Karim writes:
> Surprising comments show political difficulties of QE in Europe. With fiscal policy constrained
> and the Euro strong, that means more pressure on ‘conventional’ monetary policy: ECB to
> keep o/n rate low for long.
Yes, agreed. Shows no understanding of monetary operations whatsoever.
With the old German model they had tight fiscal to keep domestic demand and costs down to drive exports. And they also bought $US to keep the mark at ‘competitive’ levels.
With the euro they are also keeping fiscal relatively tight to keep a lid on domestic demand and costs to drive exports, but can’t buy $US for ideological reasons (that would look like the euro is backed by dollars, etc.) so instead of exports rising the currency appreciates to levels where exports remain stagnant.
Merkel attacks central banks
by Bertrand Benoit and Ralph Atkins
June 2(FT) —Angela Merkel, the German chancellor, criticised the world’s main central banks in surprisingly strong terms on Tuesday, suggesting that their unconventional monetary policies could fuel rather than defuse the economic crisis.
The attack on the US Federal Reserve, the Bank of England and the European Central Bank is remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition on never commenting on monetary policy.
“What other central banks have been doing must stop now. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,†she told a conference in Berlin.
“Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds,†she said. “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.â€
Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting monetary policy out of respect from central bank independence – suggests Berlin is far more concerned about the route taken by the ECB than had hitherto transpired.
Berlin is concerned that the central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and about the long-term inflationary potential of hyper-lose monetary policies.
The ECB’s efforts have been focused on pumping unlimited liquidity into the eurozone banking system for increasingly long periods. But last month (May), it followed the US Federal Reserve and Bank of England in announcing an asset purchase programme to help a return to more normal market conditions.
The ECB announced it had agreed in principle to buy €60bn in “covered bondsâ€, which are issued by banks and backed by public sector loans or mortgages.
The covered bond purchases, however, were only agreed after extensive discussions within the 22-strong ECB governing council. According to one version of May’s meeting, the council had discussed a €125bn asset purchase programme that would also have included other private sector assets, but only the purchase of covered bonds was agreed.
Axel Weber, ECB council member and president of Germany’s Bundesbank, has been among those who expressed scepticism about direct intervention in financial markets. In a Financial Times interview in April he expressed “a clear preference for continuing to focus our attention on the bank financing channelâ€.
Mr Weber has also been among the most proactive council members in warning that the monetary stimulus injected into the economy will have to be reduced or even reverse quickly once the economic situation improves.
Details of the covered bond purchase scheme will be unveiled by the ECB after its meeting on Thursday. One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme. Meanwhile, the ECB is widely expected to leave its main interest rate unchanged at 1 per cent, its lowest ever.
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