Posts Tagged ‘Deflation’

When not to put your money in the bank.

January 4, 2016 2 comments

Negative interest ratesIt seems that in Europe negative interest rates are common place. Below are the current rates of some central banks:

European Central Bank -0.3%
Swiss National Bank -0.75%;
Danish Central bank -0.75%
Swedish Central Bank -1.1%

Why are they in negative territory?
For all these countries it is the the exchange rate against the Euro that is important. Negative interest rates weaken a country’s currency and make imports more expensive and exports cheaper. Furthermore central banks could be trying to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery.

In theory, interest rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice, there’s a risk that the policy might do more harm than good. If banks make more customers pay to hold their money, cash may go under the mattress instead. Janet Yellen, the U.S. Federal Reserve chair, said at her confirmation hearing in November 2013 that even a deposit rate that’s positive but close to zero could disrupt the money markets that help fund financial institutions. Two years later, she said that a change in economic circumstances could put negative rates “on the table” in the U.S., and Bank of England Governor Mark Carney said he could now cut the benchmark rate below the current 0.5 percent if necessary. Deutsche Bank economists note that negative rates haven’t sparked the bank runs or cash hoarding some had feared, in part because banks haven’t passed them on to their customers. But there’s still a worry that when banks absorb the cost themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend. Ever-lower rates also fuel concern that countries are engaged in a currency war of competitive devaluations. Source: Bloomberg

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Stimulatory action to continue in the US economy

January 1, 2011 Leave a comment

In 2011 the US Federal Reserve seems likely to continue its stimulatory action with near-zero interest rates and the printing money commonly known as quantitative easing (QE). The Fed has been trying to generate inflation which would pull the US$ down and make US exports more competitive. However growth rates of 2% is not high enough to bring down the 9.6% unemployment rates.

Currently the Fed regards deflation a bigger risk that inflation and has indicated that it will avoid deflation at all costs – remember that deflation makes debts larger. However, Thomas Hoenig – a member of the Federal Open Market Committee – has constantly disagreed with QE. His rationale is that it will mean higher inflation in the future. He may well be correct as the impact of loose monetary policy and QE1 and QE2 may manifest itself in higher inflation down the track. One could say that there is a high level of uncertainty as we have never seen such a stimulus package of this level before. At present though much of the money created by the Fed still sits on the balance sheets of banks as lending growth has been anaemic. But Hoenig’s opposition to QE does have merit. QE will not lead to runaway inflation as long as the Fed is proactive to withdraw the stimulus once inflation starts to creep up. If the Fed waits too long then there is the real risk of double digit rate. The Fed needs to sell its bonds that it bought and thus take money out of the circular flow.

Historical examples – Zimbabwe, Argentina and Germany
These three countries went through a period of printing money at the expense of inflation rates well over 1000%. Zimbabwe – 2000’s, Argentina 1970’s, and Germany 1920’s. Although this seems like what the Fed is currently doing there is one very significant distinction. The Fed is printing money as part of its monetary policy. In the case of the three countries above those governments printed money as part of their fiscal policy and used the cash to pay government bills – it should be remembered that monetising the deficit leads to hyper-inflation. But isn’t this what the Fed is doing funding the government deficit by buying bonds? However the Fed is buying bonds in the secondary market and the proceeds flow to the private sector, not the government.

This stimulus should eventually start to lead to improved fundamentals in the US economy. But the Fed cannot drive economic growth by itself. Monetary policy is just one instrument of economic management. The government must also ensure that fiscal policy is conducive to generating effective deployment of resources and growth in productivity.

US Economy – where to from here?

September 3, 2010 Leave a comment

They cut interest rates, printed money and gave massive fiscal stimulus packages but still the outlook for the US economy is poor. With 9.5% unemployment – this figure is likely to be higher when the number of part-time workers are added – the economy is slowing considerably. Furthermore, as the unemployment benefit in the US is lower than European countries, this acts as a constraint on demand and in difficult times people tend to save rather than spend. From the meeting of the world’s central bankers in Jackson Hole (see posting on 29th Spetember) there are clear indications that another major shot of quantitative easing is just around the corner. However, there are those who see the problems of the US economy as too entrenched and argue that it is in serious trouble. Larry Elliott from the Gaurdian Newspaper wrote a book review of The Long Twentieth Century by Giovanni Arrighi in which he talks about ceratin prevalent issues including:
– the dominance of Wall Street
– the structural trade deficit
– the military’s overestimate of its abilty
– the switch from being the world’s biggest creditor to biggest debtor

All of which, Arrighi suggests, will lead to the demise of the American economy. Albert Edwards, an analyst at French bank Societe Generale who correctly predicted the Asian financial crisis, sees global equity markets at a new low and chances of another global recession in 2010. He refers to the current situation as unprecedentedly strong monetary and fiscal stimulus has led to unprecedentedly weak recovery. Ben Beranake will be aware of this and Japan’s lost decade and will do everything to keep the economy moving. Remember he did his PhD on the Great Depression but will need all his expertise to get the US economy back on track.

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