Friday, November 10, 2006
Hungary Economy Watch
I have a new blog: Hungary Economy Watch. Next year is likely to be an interesting one in Hungary, and many of the issues surrounding the Lynx economies, and the sustainability of heavy deficit financing in the face of rapidly ageing populations are possibly going to be played out there, and if they are, then I will be watching.
Money Supply As An Economic Forecaster
Are money supply figures a useful measure of future economic performance? Well Ben Bernanke certainly doesn't seem terribly convinced they are:
"Forecast errors for money growth are often significant, and the empirical relationship between money growth and variables such as inflation and nominal output growth has continued to be unstable at times," Bernanke said in prepared remarks to a European Central Bank conference in Frankfurt.
As is well known ECB President Jean-Claude Trichet isn't terribly convinced by Bernanke's argument at this point, and throwing off suggestions that he was a 'monetary luddite' Trichet told the FT yesterday that despite the fact that other central banks, including the US Federal Reserve, are sceptical about the use of such measures and despite his acknowledgement that “the dominant academic view seems to be that monetary aggregates should have no part in monetary policy decisions”, he still “cannot dispel my doubts that a model of monetary policy that includes no role for money is incomplete in some important respects.”
Of course I doubt that anyone, including Ben Bernanke, is suggesting there should be *no* role for monetary aggregates. What is at issue is the importance you give to those aggregates and the interpretation you put on them. This is the main point at issue in the Eurozone at the present time.
Which takes us back to a debate that the Morgan Stanley GEF team had in July 2005 about whether or not the Eurozone economies might have slipped into a sort of liquidity trap (here's a link to the debate itself, which was very interesting). Now it is extremely unlikely that the entire Eurozone would be in such a trap, but some parts of it - and especially the German economy - are notably resistant to large increases in available liquidity.
Who is right? This is a good question, and one Claus Vistesen has been struggling to get to grips with himself:
So who is right? Well, I have argued continously here at Alpha.Sources that I think the ECB is playing into the hands of the impending recessionary outlook for the Eurozone going into 2007 raising rates. Inflation is below target as a result of a dropping headline and the recovery itself is anything but sustainable. However, the broad based monetary indicator (M3) is still above target and corporate and private lending remains buyoant. But do I really side with the finance ministers here?
It really does not matter in this case since the real point here is that the ECB is a central bank and as such (should be) independant from policy. We have had this discussion before and despite all my rants about the inherent problems of the Euro as a project the independance of the ECB as an institution is very important ... if it was to become a quasi-political forum we might as well shut the whole thing down. Underneath this is of course the underlying paradox of the ECB's task of keeping a single interes rate to suit all Eurozone economies faced with huge strucutural imbalances which in my opinion (and get ready here) first and foremost are driven by the widely differing population structures of the Eurozone countries.
Here maybe it would be appropriate here top leave the last word to uncle Milton himself. Try this from a sort of minor scoop I had here on Bonobo some time back: Targeting the Quantity of Money........"has not been a success"
Hold on to your hats and prepare to be amazed: Milton Friedman has changed his mind. "The use of quantity of money as a target has not been a success," concedes the grand old man of conservative economics. "I'm not sure I would as of today push it as hard as I once did." Granted, this is hardly a conversion of Damascene significance. But, heck, it's a start. It also shows that, at the age of 91, Friedman still has his critical faculties intact. The man once described as "the most consequential public intellectual of the post-war era" is still engaged - and engaging.
"Forecast errors for money growth are often significant, and the empirical relationship between money growth and variables such as inflation and nominal output growth has continued to be unstable at times," Bernanke said in prepared remarks to a European Central Bank conference in Frankfurt.
As is well known ECB President Jean-Claude Trichet isn't terribly convinced by Bernanke's argument at this point, and throwing off suggestions that he was a 'monetary luddite' Trichet told the FT yesterday that despite the fact that other central banks, including the US Federal Reserve, are sceptical about the use of such measures and despite his acknowledgement that “the dominant academic view seems to be that monetary aggregates should have no part in monetary policy decisions”, he still “cannot dispel my doubts that a model of monetary policy that includes no role for money is incomplete in some important respects.”
Of course I doubt that anyone, including Ben Bernanke, is suggesting there should be *no* role for monetary aggregates. What is at issue is the importance you give to those aggregates and the interpretation you put on them. This is the main point at issue in the Eurozone at the present time.
Which takes us back to a debate that the Morgan Stanley GEF team had in July 2005 about whether or not the Eurozone economies might have slipped into a sort of liquidity trap (here's a link to the debate itself, which was very interesting). Now it is extremely unlikely that the entire Eurozone would be in such a trap, but some parts of it - and especially the German economy - are notably resistant to large increases in available liquidity.
Who is right? This is a good question, and one Claus Vistesen has been struggling to get to grips with himself:
So who is right? Well, I have argued continously here at Alpha.Sources that I think the ECB is playing into the hands of the impending recessionary outlook for the Eurozone going into 2007 raising rates. Inflation is below target as a result of a dropping headline and the recovery itself is anything but sustainable. However, the broad based monetary indicator (M3) is still above target and corporate and private lending remains buyoant. But do I really side with the finance ministers here?
It really does not matter in this case since the real point here is that the ECB is a central bank and as such (should be) independant from policy. We have had this discussion before and despite all my rants about the inherent problems of the Euro as a project the independance of the ECB as an institution is very important ... if it was to become a quasi-political forum we might as well shut the whole thing down. Underneath this is of course the underlying paradox of the ECB's task of keeping a single interes rate to suit all Eurozone economies faced with huge strucutural imbalances which in my opinion (and get ready here) first and foremost are driven by the widely differing population structures of the Eurozone countries.
Here maybe it would be appropriate here top leave the last word to uncle Milton himself. Try this from a sort of minor scoop I had here on Bonobo some time back: Targeting the Quantity of Money........"has not been a success"
Hold on to your hats and prepare to be amazed: Milton Friedman has changed his mind. "The use of quantity of money as a target has not been a success," concedes the grand old man of conservative economics. "I'm not sure I would as of today push it as hard as I once did." Granted, this is hardly a conversion of Damascene significance. But, heck, it's a start. It also shows that, at the age of 91, Friedman still has his critical faculties intact. The man once described as "the most consequential public intellectual of the post-war era" is still engaged - and engaging.
Concern Over Japanese Recovery Grows
FT Tokyo correspondent David Pilling is no fool. He may have overly bought the recent 'sustained recovery' story, but he certainly has not surrendered all his critical faculties and he continues to be one of the more 'on the ball' commentarists as far as things Japanese go. Two recent articles make this plain.
In the first place he is aware of the risks associated with a 'pre-emptive raising of rates by the Bank of Japan:
Japan's central bank will move pre-emptively against inflation, Toshihiko Fukui, Bank of Japan governor, said on Tuesday in comments that increase the likelihood of a further rate rise before the end of the year.
His remarks reinforce the bank's insistence that it will not tie its policy to the headline rate of inflation, which has been sliding, partly due to technical factors.
This allows no buffer against slipping back into deflation, and the bank has resisted hitching its policy to a specific inflation target.
Jonathan Allum, Japan strategist at KBC Financial Products, said: "The nightmare scenario is that A: you begin to see evidence of economic contraction, B: you get a return to deflation, and C: the Bank of Japan ignores all this and tightens anyway."
Mr Allum said the economy had been slowing for nearly a year and that it could even contract in the third quarter because of sluggish consumer spending. "Clearly there is a danger that the BoJ is too gung-ho in its view of the economy," he said. "If energy prices are excluded, as they are in most economies, Japan is still in deflation."
The consumer price index, excluding fresh food but including energy, rose 0.2 per cent over the previous year in September, lower than expected. Excluding energy prices, it fell 0.5 per cent. If oil prices remain constant, economists say the headline rate could fall back into negative territory in the first quarter of next year.
Hiroshi Shiraishi, economist at Lehman Brothers, said the BoJ was prepared to ignore the headline number. "The BoJ is not tied to the current reading of CPI," he said. "That's going to give you the wrong answer [in predicting the next rate rise]. They are looking one or two years ahead and they are confident that the Japanese economy has ended the adjustment process and that the output gap has been closed."
Mr Shiraishi said one danger of a premature rate increase was that there could be a rapid reversal in the carry trade, where investors borrow cheaply in yen to buy higher-yielding foreign assets. If money flowed back to Japan it could push up the yen sharply, potentially damaging exports.
Secondly, and today, he draws our attention to the problem of 'recovery derailment' presented by any attempt to tighten fiscal policy (something which at some point is inevitable in Japan, given the scale of the debt):
Japan can continue its controversial policy of cutting public spending without damaging the country’s growth prospects, Koji Omi, finance minister, told the Financial Times in an interview on Thursday.
In a strong defence of government policy, Mr Omi said: “Our thinking is that economic growth and financial consolidation are compatible rather than contradictory.” He believed the economy remained fundamentally strong.
Mr Omi’s comments precede next week’s release of official figures for third-quarter gross domestic product growth. A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried that output may have shrunk in the three months to September.
Paul Sheard, global chief economist at Lehman Brothers, said he was concerned that Japan’s economic authorities were applying the brakes at the wrong time. “The big picture in Japan is that deflation continues and monetary and fiscal policy are both being tightened,” he said. “I challenge you to find any textbook where that is described as an optimal policy mix.”
So the big picture here is that A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried and The big picture in Japan is that deflation continues. All this seems to me to be so obvious, but it is evidently not obvious to everyone. Nonetheless not everyone is getting it wrong on Japan bigtime, Claus Vistesen for example, who again today has another timely post explaining the ins and outs of what is actually happening in Japan.
In the first place he is aware of the risks associated with a 'pre-emptive raising of rates by the Bank of Japan:
Japan's central bank will move pre-emptively against inflation, Toshihiko Fukui, Bank of Japan governor, said on Tuesday in comments that increase the likelihood of a further rate rise before the end of the year.
His remarks reinforce the bank's insistence that it will not tie its policy to the headline rate of inflation, which has been sliding, partly due to technical factors.
This allows no buffer against slipping back into deflation, and the bank has resisted hitching its policy to a specific inflation target.
Jonathan Allum, Japan strategist at KBC Financial Products, said: "The nightmare scenario is that A: you begin to see evidence of economic contraction, B: you get a return to deflation, and C: the Bank of Japan ignores all this and tightens anyway."
Mr Allum said the economy had been slowing for nearly a year and that it could even contract in the third quarter because of sluggish consumer spending. "Clearly there is a danger that the BoJ is too gung-ho in its view of the economy," he said. "If energy prices are excluded, as they are in most economies, Japan is still in deflation."
The consumer price index, excluding fresh food but including energy, rose 0.2 per cent over the previous year in September, lower than expected. Excluding energy prices, it fell 0.5 per cent. If oil prices remain constant, economists say the headline rate could fall back into negative territory in the first quarter of next year.
Hiroshi Shiraishi, economist at Lehman Brothers, said the BoJ was prepared to ignore the headline number. "The BoJ is not tied to the current reading of CPI," he said. "That's going to give you the wrong answer [in predicting the next rate rise]. They are looking one or two years ahead and they are confident that the Japanese economy has ended the adjustment process and that the output gap has been closed."
Mr Shiraishi said one danger of a premature rate increase was that there could be a rapid reversal in the carry trade, where investors borrow cheaply in yen to buy higher-yielding foreign assets. If money flowed back to Japan it could push up the yen sharply, potentially damaging exports.
Secondly, and today, he draws our attention to the problem of 'recovery derailment' presented by any attempt to tighten fiscal policy (something which at some point is inevitable in Japan, given the scale of the debt):
Japan can continue its controversial policy of cutting public spending without damaging the country’s growth prospects, Koji Omi, finance minister, told the Financial Times in an interview on Thursday.
In a strong defence of government policy, Mr Omi said: “Our thinking is that economic growth and financial consolidation are compatible rather than contradictory.” He believed the economy remained fundamentally strong.
Mr Omi’s comments precede next week’s release of official figures for third-quarter gross domestic product growth. A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried that output may have shrunk in the three months to September.
Paul Sheard, global chief economist at Lehman Brothers, said he was concerned that Japan’s economic authorities were applying the brakes at the wrong time. “The big picture in Japan is that deflation continues and monetary and fiscal policy are both being tightened,” he said. “I challenge you to find any textbook where that is described as an optimal policy mix.”
So the big picture here is that A sharp contraction in private consumption, down 1 per cent quarter on quarter, has some economists worried and The big picture in Japan is that deflation continues. All this seems to me to be so obvious, but it is evidently not obvious to everyone. Nonetheless not everyone is getting it wrong on Japan bigtime, Claus Vistesen for example, who again today has another timely post explaining the ins and outs of what is actually happening in Japan.
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