Careless tapering talk may cost the economy
It is hard to manage a policy whose effects depend on expectations. But it must be done better – this tightening of monetary policy is premature
A police officer guarding the Federal Reserve building in Washington, DC: the challenge in unwinding current policies is not technical. As Fed chairman Ben Bernanke explained in February 2010, exit from quantitative easing and bloated central bank balance sheets is technically straightforward. Photograph: Andrew Harrer/Bloomberg
Since the beginning of May, monetary policy has undergone a substantial tightening. This has taken the form of a rise in the yield on the bonds of highly rated governments. The yield on 10-year US treasuries rose by 88 basis points between May 2nd and the end of last week, to 2.51 per cent. This is a clear tightening of monetary conditions: a rise in these yields leads to rising borrowing costs for the private sector. It is, however, not clear it is deliberate: longer-term bond yields are not an explicit target for monetary policy. Moreover, part of the reason for the jump in rates is rising confidence. But talk of “tapering” US quantitative easing is also a factor. It is hard to manage a policy whose effects depend on expectations. But it must be done better: this tightening is premature.
That is surely not how it would appear to the Bank for International Settlements, whose annual report calls for an early end to loose policies: “Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets. Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system, and ensure that banks set aside sufficient capital to match the associated risks.”
Central bank bromide
This is central bank bromide. Worse, it is hard to understand how the BIS thinks its recommendations add up across the world economy. In essence, it suggests that the private sectors should run bigger financial surpluses, as heavily indebted agents repay debt, while governments should run smaller deficits. Unless one assumes that advanced countries will run vast current account surpluses with the rest of the world, this is a plan for a depression. The BIS does not even consider the possibility that monetary policy has been ineffective because it is competing with the fiscal tightening the BIS has recommended.
At least three further points stand out. First, the two crisis-hit economies that have made greatest use of unconventional monetary policy – the US and the UK – are also the least affected by structural rigidities so there is no moral hazard there. Only sadists can argue that supportive monetary conditions have cushioned southern Europe against the need to reform. Second, it ignores the fact that one of the reasons for failure to reduce debt faster is economic weakness caused by the austerity it supports. Third, core inflation is low and falling in the US and euro zone. Rapid tightening risks tipping these economies into outright deflation – a risk the BIS does not even mention.
Indeed, in a critique of the Federal Open Market Committee’s latest policy statement, James Bullard, president of the Federal Reserve Bank of St Louis, argues that the committee “should have more strongly signalled its willingness to defend its inflation target of 2 per cent in light of recent low inflation readings”. He is right: the Federal Reserve’s forecasts show core inflation at or below 2 per cent up to and including 2015. Also, he argues “the committee’s decision to authorise the chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed”. It should have waited “for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement”. I agree.