Bill, Stanley... Janet Next?
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The ‘triumvirate’ of Dudley, Fischer and Yellen are usually regarded by the markets as setting the tone for FOMC debate. So the likelihood is that Yellen is set to echo these comments which could easily force a re-pricing of interest rate expectations in the market.
Determining the Fed’s policy stance has kept market economists employed for many a year and this year has been no different even though at times it seems like a fruitless task. Clearly though, this time is different and economists have had to contemplate the reality of unconventional monetary policies becoming conventional. Before the 2007-2008 financial crisis, Fed-watchers recognised a regular economic cycle where recessions were mild and brief, where inflation deviated little from its 2% target and in each of the past four economic downturns the Fed had room to cut the fed funds rate by more than five percentage points. Post-crisis, Fed-watchers have had to contend with ZIRP, QE and perhaps NIRP and helicopter money (readers might be interested in an easy-to-read primer on the latter by Professors Cecchetti and Schoenholtz here).
All of these policy options are a reaction to a new economic landscape in the US and some of the other major economies, especially Japan and the Eurozone, where economic growth has typically been below trend. This backdrop has coincided with longer term declines in productivity growth and weak investment which has given rise to the ‘secular stagnation’ narrative which emphasises a chronic deficiency in demand as well as the impotence of monetary policy at the zero lower bound.
There are structural factors at work, such as adverse demographics, which affect the labour participation rate as well as technological advances that are labour-saving. There is also a growing body of research which argues that the overhang of debt acts as a restraint on economic growth. Nevertheless, the ECB, BoJ and now the BoE again are buying bonds via their QE programmes amounting to USD 180bn even though record lows in government bond yields in the major economy have little discernible effect in terms of securing a sustainable economic recovery.
Now the debate amongst investors and economists is whether monetary policy in the major economies has not only reached the limits of its effectiveness but also whether policies such as negative interest rates are actually counter-productive. Annualised credit growth is just 3.5% and is insufficient to generate meaningful GDP growth. Banks are unwilling to lend, either because of increased regulatory requirements or because negative interest rates act as a tax. Borrowers do not want to borrow because they already have high debt levels.
Gross rightly makes the point that all financial assets are a bet on growth and inflation in that nominal growth (real GDP+ inflation) allows a country, company or individual to service their debts with increasing income. Otherwise, a credit-based economy ultimately devolves into Ponzi finance and at some point implodes. So for the US economy, nominal GDP growth of 4% is a necessary requirement to avoid this fate.
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