The spirit of christmas present ...

Economics news –  the spirit of Christmas present is a cheerful spirit ...

The spirit of Christmas Past - should not be forgotten. The spirit of Christmas Present - is a cheerful spirit. The spirit of Christmas Yet to Come suggests that it is unlikely that equilibrium interest rates will return to historically normal levels any time soon”. Excellent. Don’t you just love a central banker with a Christmas message. Governor Carney was speaking in New York this week at the Economic Club of New York.

The Governor is anxious to secure the message, interest rates will not rise any time soon. The recovery will not be put at risk. The UK will achieve escape velocity from a liquidity trap, avoiding secular stagnation in the process. Forward guidance is the new policy mantra, secular stagnation the new spectre on the blog. The UK is set for recovery, despite the prophets of gloom on either side of the Atlantic.

Forward guidance is integral to the central bankers response to the recession and setback. FG reduces uncertainty, providing reassurance that monetary policy will not be tightened before the recovery is sufficiently established. Businesses will have the confidence to invest. Households will have the confidence to spend. A liquidity trap is avoided.

A liquidity trap occurs when the short-term nominal interest rate hits the zero lower bound. Typically in a liquidity trap, inflation is low, the equilibrium real interest rate is negative, creating a persistent inability to match aggregate demand and supply. Businesses won’t invest and consumers are reluctant to spend, aggregate demand continues to fall and a deflationary spiral develops. Fiscal constraints ensure Government spending cannot bridge the output gap.

In the UK, the financial crisis pushed the equilibrium real interest rate to the lower bound. With nominal interest rates stuck at zero, and inflation low, monetary policy was unable to push actual real rates to a level low enough to generate growth allegedly. “Pushing on a string, is no way to wag the dog”. I think Keynes said that. Hence the emergence of QE on Planet ZIRP. Allegedly, a way to stimulate liquidity AND activity. In reality, a great way to undermine the gilt curve and returns to savers and investors in the process.

So what of secular stagnation? Larry Summers had recently raised the spectre of secular stagnation at the IMF meeting in November in honour of Stanley Fischer, guru of monetary theory at MIT. Secular stagnation, a concept first developed by Alvin Hansen in the 1920s suggested the “new normal” in the USA (post depression) was of lower growth, primarily a result of lower population growth and technological exhaustion. No new things to boost productivity, that sort of thing.

Larry Summers, resurrected the term, suggesting the short term real interest rate consistent with full employment may have fallen to -2% -3% in the middle of the last decade. “The natural and equilibrium interest rates may have fallen significantly below zero”. “We may have to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity holding our economies back below their long run potential.” he said.

In theory, the Fed funds rate can be kept at ZIRP forever but it is much harder to do “extraordinary additional stuff” forever” either in the form of QE, or government deficit funding perhaps. This said Summers, is “my” lesson from this crisis which the world has “under internalised”.  

Actually Summers went on to say “Now this may all be madness and I may not have this right at all”. Mmm.

Stuck on Planet ZIRP, QE was introduced, the effect of which, was to ensure we were marooned on the planet for longer. ZIRP creates of itself a problem which is compounded by QE. In the UK, QE has lost intellectual credibility and momentum but in the USA the persistent purchase of Treasuries and Mortgages (CMBS) continues, achieving no more for Uncle Sam, than a monthly dispensation into a NASDAQ tracker fund. It really is time to begin tapering in the US, end QE and return the equilibrium rate of interest to a natural rate. A natural rate for gilts and treasuries, which reflects an inflation hedge and a real rate of return to risk.

In his speech, Summers said, “we have learned one thing, finance cannot be left to the financiers”. Perhaps but then I have always felt much the same about monetary economics.

We should begin to think how we can manage an economy in which the academics are confined to campus and not allowed near policy levers. The concept of a negative equilibrium interest rate, which may have fallen to -3% pre recession is as incomprehensible, as life on Planet ZIRP without oxygen. The escape from ZIRP and the beginning of recovery can only be accelerated by an end to QE. Let the free markets free and end QE - the cry. It is time to suggest “Schools out for Summers” and the MIT class of 14462. The US is set to grow by over 2.5% next year or has no one noticed.

Back in the UK
Back in the UK, as expected the march of the makers picked up the pace in October.  Manufacturing growth year on year increased to 2.7% in the month. Construction output grew at over 5% in the latest data for October. The trade figures on the other hand continued to disappoint. The UK's deficit on trade in goods and services was estimated to have been £2.6 billion in October 2013, unchanged from September. The deficit of £9.7 billion on goods, partly offset by an estimated surplus of £7.1 billion on services.

Yes, the march of the makers is picking up pace, momentum is “building”, investment plans will be brought back to the board room, just the trade figures alone will continue to disappoint, as the UK recovery gains pace.

What happened to sterling?
The pound closed at £1.6294 from £1.6346. Against the Euro, Sterling closed at €1.1856 from €1.1922. The dollar moved down up the yen closing at ¥103.2 from ¥102.8 and closing at 1.3740 from 1.3700 against the Euro. Sterling is on a rally which has led to a break out above £1.60, but €1.20 still presents significant overhead resistance.

Oil Price Brent Crude closed at $108.83 from $111.61. The average price in December last year was almost $110, so no threat to inflation.

Markets, US moved lower - The Dow closed at 15,755 from 16,020. The FTSE closed at 6,434 from 6,552. 7,000 FTSE now a tough call before Christmas. The markets still nervous until tapering finally begins.

UK Ten year gilt yields closed at 2.90 from 2.91 US Treasury yields closed at 2.87 from 2.86. Yields will test the 3% level over the coming months but this will await the New Year.

Gold closed at $1,239 from $1,231.

That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow and watch out for news of our Monthly Markets updates coming in the New Year.

John

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