A blind guide dog

‘Forward guidance’ is the central bank buzz-word.  Three of the top four central banks in the world have now officially adopted it.  And the fourth has already made it very clear where its monetary policy is going.  Forward guidance is an attempt by the leading central banks to indicate more clearly what monetary policy will be for a reasonable period ahead along with the conditions for sustaining it. It aims to allow households, businesses and financial markets to know what to expect in central bank base rates for the foreseeable future.  In the current environment of low growth, high unemployment and an overhang of capacity, central bankers hope that forward guidance will exert downward pressure on long-term interest rates as economies recover.

Following their December 2012 meeting, US Federal Reserve policymakers announced their new policy of ‘forward guidance’. The Federal Open Market Committee (FOMC) said it forecast that a target range for the federal funds rate of 0-0.25% will be kept for as long as the unemployment rate remained above 6.5%, inflation between one and two years ahead rose no more than 50bp above the FOMC’s target of 2% a year, and longer-term inflation expectations remained ‘well anchored’. The FOMC reckoned that this meant the federal funds rate would be unchanged at least through mid-2015. The thresholds for unemployment and inflation were not trigger points for an immediate change of policy, but points when the FOMC would consider its options.

More recently, the European Central Bank has adopted its variation on ‘forward guidance’. In July, its governing council said it expected to keep its refinancing and deposit rates at present levels ‘for an extended period of time’, assuming it was right in its forecast of subdued inflation, weakness in the Eurozone economy and low credit growth.

And only last week, the Bank of England (BoE) joined the party, when its new governor, Mark Carney, former governor at the Bank of Canada, made his first monetary statement and announced that the BoE would introduce forward guidance too. The BoE followed the Fed, as usual, in almost exactly the same terms of guidance. It pledged to keep its base rate at its lowest level in its 300-year history until unemployment falls to 7% from its current level of 7.8%. How long would that take? The UK’s Monetary Policy Committee (MPC) reckoned that that unemployment ‘knockout’ target would not be reached until mid-2016 after the creation of about 750,000 more net jobs. However the MPC couched that guidance with some caveats. If the annual inflation rate looked like staying at 2.5% or higher in the medium-term, or if inflation expectations were out of control, or if the policy was threatening financial stability, then interest-rate policy could change earlier.

The reality is that ‘forward guidance’ from central banks is to the blind capitalist investor is being done by blind guide dogs.  Neither Bernanke nor Carney have any idea where unemployment, GDP growth and inflation will be next year, let alone in two or three years time.  The efficacy of this new policy is thus shot through with holes.

Forward guidance is really an addition to quantitative easing (QE), the policy of the central bank buying financial assets, like government or corporate bonds and printing the money to do so.  The idea is that with interest rates already near zero, the only way for the central bank to stimulate the capitalist economy is to boost the quantity of money rather than lower its price (interest rate).  But QE is based on a fallacy that increasing supply of money can lower its cost or price, in other words, the price of money can be set exogenously to the transactions made by banks and other lenders and borrowers of money and credit.  Actually, the demand for money is endogenously, by the decisions of capitalists to invest and consumers to buy (see my posts, https://thenextrecession.wordpress.com/2013/06/26/the-failure-of-qe-2/  and https://thenextrecession.wordpress.com/2012/08/25/qe-uk-banks-and-the-economy/).

While investment remains low and consumption is muted, the demand for more money is low.  So all that happens to this supply of ‘liquidity’ is that it flows into the purchase of financial assets and property, the unproductive sectors of the economy.  So the stock market is booms and house prices inflate, while the real economy stays weak.  A recent paper by Vasco Curdia and Andrea Ferrero at the Federal Reserve Bank of San Francisco (Efficacy of QE) found that the Fed’s QE measures from 2010 had helped to boost real GDP growth by just 0.13 percentage points and the bulk of this ‘boost’ was thanks to forward guidance, namely convincing investors that interest rates were not going to rise.  If that factor had been left out, the US real GDP would have risen only 0.04 per cent as a result of QE.

So if QE continues and interest rates are kept low until 2016 as Carney and Bernanke plan, then any boom will take place in property and the stock market not the real economy.  Already we have seen a sharp rise in home prices in both the US and the UK in the last year.

The UK’s consumer price inflation has always been higher than in the rest of Europe, partly because the UK is a rentier, service economy, with monopoly companies in many key sectors, which have pricing power, while pro-capitalist governments have raised indirect tax rates in many sectors, like travel, insurance, energy.  The inflation figure for July is just out at 2.8 yoy, down slightly from 2.9% yoy in June.  That’s still way higher than Carney’s target of 2% a year.  Factory gate inflation rose at its fastest pace in six months and further rises look set to come, with manufacturers crude oil input costs rising at their most rapid rate in over a year.

Even more significant is the move up in house prices.  The Royal Institution of Chartered Surveyors’ monthly survey pointed towards the biggest rise in house prices since 2006 and official data showed house prices rising faster than inflation at an annual 3.1%.  House prices in London were racing along at 8.1%.

And this is at a time when UK average earnings from work are rising at just 1% a year.  Indeed, wages in the UK have seen one of the largest falls in the European Union during the economic downturn.  Average hourly wages have fallen 5.5% since mid-2010, adjusted for inflation.  That is the fourth-worst decline among the 27 EU nations. Across the European Union as a whole, average wages fell 0.7%.  Only Greek, Portuguese and Dutch workers have had a steeper decline than the UK in hourly wages.  The Institute for Fiscal Studies said that a third of British workers who stayed in the same job saw a wage cut or freeze between 2010 and 2011 amid a rise in the cost of living. “The falls in nominal wages… during this recession are unprecedented,” the IFS said.

So with the biggest fall in real incomes in a generation, what does the UK’s new governor do?  He announces ‘forward guidance’ that will mean higher house prices and bigger speculative profits for the stock market.  After doing so, Carney had a weekend off in upper-class Oxfordshire, the British version of the US east coast Hamptons.  Apparently, according to news reports, Carney is a clubbable, “very social” man who mixed “among the movers and shakers” of Canadian society.  Now he has joined the so-called Chipping Norton Set — the group of powerful friends who live in Oxfordshire, including UK PM David Cameron and members of the international media mogul family, the Murdochs.  Carney is married through his wife Diana into a family of British aristocrats.  Diana is apparently “an outspoken economist who has written about the need to rebalance global wealth towards the poorest!”  economist who has written about the need to rebalance global wealth towards the poorest”!  A senior UK government source described Carney as “the perfect Davos man” — referring to the annual gathering of decision-makers in the Swiss ski resort where contacts and smooth-talking oil big deals.

So the Fed and the BoE will continue with useless ‘forward guidance’ that will only fuel a credit boom for the rich, while inflation and house prices spiral for the rest of us.  It’s the rich leading the blind.

America’s experiment with QE has just been assessed by a team of economists. Some of their findings may be relevant for the UK. In a paper for the Federal Reserve Bank of San Francisco, Vasco Curdia and Andrea Ferrero are dismissive.
They find that QE2 added just 0.13 percentage points to GDP growth in late 2010 and 0.03 percentage points to inflation; that the bulk of this was thanks to forward guidance (without it, GDP would have risen 0.04 per cent and inflation 0.02 per cent) and that cutting rates by a quarter of a point has a bigger effect than QE2. Given QE’s side-effects, it’s not exactly what you call a great policy.

– See more at: http://www.cityam.com/article/1376355091/greece-s-catastrophic-1930s-style-depression-salutary-tale?utm_source=homepage_puff&utm_medium=homepage_puff&utm_term=pufftest&utm_campaign=homepage_puff#sthash.VbvB2o3H.dpuf

4 thoughts on “A blind guide dog

  1. “Actually, the demand for money is endogenously, by the decisions of capitalists to invest and consumers to buy.”

    But, according to Marx interest rates are determined by the demand and supply for money-capital not money. Its because the rate of profit and volume of profit has been high an rising for the last 30 years that interest rates have been falling. Now that is reversing and interest rates will be rising whatever Central Banks do.

    Bernanke has kept emphasising that QE will continue even if scaled back but the US 10 Year has gone from 1.4% to 2.75%, UK 10 year Gilts have gone from 1.5% to 2.5%, and even went up last week even as Carney was promising three years of frozen interest rates.

    In Japan, as the Central Bank promised to double the money supply to create 2% inflation, the JGB trebled!

    Inflation in Britain even on the fiddled figures has been way above target for more than 5 years, and today came in above forecasts. More money printing under current conditions means rapidly rising inflation of consumer goods prices because the days of ever cheaper commodities from China are over.

    Large amounts are coming out of mutual bond funds, and why would you keep money in bonds with inflation rising?

  2. Not quite sure that the idea of the money issued by the central bank ‘flows’ into the purchase of financial assets. The money inevitably stays in the hands of the banks since it is in the form of credit accounts of these banks with the Bank of England. Purchases by the banks of other financial assets do not cause the money to flow anywhere else. If bank buy shares from investment trusts, there is not ‘flow’ of base money involved. It is just a book keeping operation in which the cash accounts of the investment trusts are credited by the banks, whilst the bank aquires shares as assets.
    Overall what occurs is a rebalancing of the asset mix held by the bank who attempt to reduce the share of assets in the form of almost non interest bearing central bank deposits and increase the share of assets in the form of interest of dividend bearing assets. The desired change in the proportion of assets held can only, if there is no new issues of equity, take the form of a revaluation of the the financial assets. There are no flows of the original money involved at all.
    The only circumstances in which there could be a flow of the new money would be if the bank bought new equity or new bonds that were used to actually fund enhanced employment. Only at that point would any of the new money actually flow out of the banks as cash in the hands of these new employees and as flows back to the treasury in the form of income tax.

    1. “If bank buy shares from investment trusts, there is not ‘flow’ of base money involved.”
      -> I think this is not so. In this case, as you said, “the cash accounts of the investment trusts are credited by the banks, whilst the bank aquires shares as assets” and new money will actually flow out of the banks whenever they withdraw money from their bank accounts.

      “The only circumstances in which there could be a flow of the new money would be if the bank bought new equity or new bonds that were used to actually fund enhanced employment”.
      -> I disagree with this as well. Since banks purchase new equity or new bonds not with the central bank money but with their own liabilities, usually deposits, unless the new employees redeem those bank liabilities into cash, there could possibly be no outflow of the new money even in the circumstance discribed in this quote.

      The point is that the actual flow of the Fed-printed money out of the private banking system into the economy depends on the nonbank public’s credence on the banks.

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