In November 2014, the Federal Reserve (Fed) was the first to act and ended its third wave of Quantitative Easing (QE). The Fed then began to raise its federal funds rate very gradually from December 2015. As of October 2017, the U.S. central bank is working to reduce the size of its huge balance sheet, which culminates to about USD 4,500 bn, by ceasing to reinvest the proceeds it receives from maturing bonds in new papers. In November 2017, the Bank of England raised its key interest rate for the first time in 10 years while maintaining its QE program unchanged (GBP 435 bn). Finally, from January 2018, the European Central Bank is starting its turn towards less accommodation in the conduct of its monetary policy, by halving the purchase amounts of its QE until September 2018 (from EUR 60 to 30 billion per month).
As a result of these prospects on both sides of the Atlantic, a greater number of investors (83% according to a recent survey by Bank of America Merrill Lynch) believe that the bond markets are overvalued. Although this seems obvious, the fact that this obviousness has become consensual speaks volumes about what should happen in 2018 and beyond. Technically, as major central banks that have adopted QE policies since the 2007-2008 financial crisis normalize their monetary policies, the supply of paper available to “conventional” investors is expected to increase in the sovereign bond markets, thus lowering the prices of these assets.
While inflationary pressures are still too slow to anticipate a quicker tightening of monetary policies by major central banks, the absence of wage inflation bodes well. Indeed, if significant inflationary pressures appear on wages, this first sign of the business cycle peak, first in the United States, would be indicative of a much more rapid tightening of U.S. monetary policy. This sequence could have a significant impact on financial stability as the paradigm shift may be too abrupt.
Although the major central banks have been able to innovate with instruments, monetary policy goals have remained unchanged. Perhaps it would be time to do the accounts and review these goals, especially inflation targets at a time when low inflation appears more structural than cyclical. Those who have spent a decade fighting fires following the bankruptcy of Lehman Brothers should not turn into pyromaniac firefighters during the next global economic and financial crisis.
Julien Moussavi, Head of Economic Research
WEEKLY FOOD FOR THOUGHT
About fiscal policy usefulness
Average response to fiscal stimulus shock in 20 developed countries* (Auerbach/Gorodnichenko)
Starting from the idea that the current expansion will sooner or later give way to a recession, Alan Auerbach and Yuriy Gorodnichenko (2017) wondered, in the working paper they recently presented at the Jackson Hole Economic Symposium, if any fiscal stimulus would be jeopardized by current high levels of public debt. By studying a sample of twenty developed countries, they confirm that increases in public spending stimulates activity and that the size of the public expenditure multiplier depends on the position in the cycle: a stimulus will impact economic activity to a greater extent when the economy is depressed than when it is expanding. In addition, they find that public expenditure shocks do not lead to lasting increases in public debt-to-GDP ratios or financing costs for fiscal authorities, especially during periods of economic slump. The chart below highlights the average response to government spending shock found by Auerbach and Gorodnichenko (bars in red and blue gradient are statistically insignificant). “Specifically, macroeconomic responses to cuts to government spending (recall that IMF shocks are fiscal consolidations) do not appear to lead to beneficial results in terms of reduced borrowing costs or persistently lower debt burdens” according to the authors. Indeed, not only do fiscal stimuli carried out in depressed economies stimulate production, they also improve fiscal sustainability according to the various indicators that Auerbach and Gorodnichenko study. In short, it is unlikely that a government will see its interest rates or its debt ratio rise sharply when it increases its spending to face a recession, even if its public debt is initially high.
Sources : Beyond Ratings, Auerbach et Gorodnichenko (2017)
Happy New Year…!
Happiness score by country (self-evaluation)
5 years after the first release, the Sustainable Development Solutions Network (SDSN) published its 6th World Happiness Report in 2017 and we wish you to be as happy as a Norwegian or a Dane wherever you live. Authors found relationships between happiness and 6 key aspects: GDP per capita, social support, healthy life expectancy, freedom to make life choices, generosity and perceptions of corruption. One country has even decided to evaluate the efficiency of its policies in terms of happiness and created a specific index: the Bhutan and its Gross National Happiness (GNH). In addition to the previous 6 components, it takes also into account spirituality (frequency of karma consideration or meditation), education, DriglamNamzha (appropriate behavior in formal occasions) or time-use (balance between paid work, unpaid work and leisure). Choose the measure that works for you, and don’t worry, be happy!
Sources: Beyond Ratings, SDSN
CO2 decreasing but non-CO2 GHGs growing in almost all G20 countries
5-year trend (2011–2016) in CO2 vs. non-CO2 emissions per country/region for G20 countries*
While most greenhouse gas analyses often focus on CO2, other GHG emissions are also key in the fight against climate change, in particular methane (CH4) and nitrous oxide (N2O). In fact, CO2 represents only 25% of total GHGs. But there is another less well-known reason for which it is essential to look at non-CO2 emissions. As described in the present graph, CO2 emissions tend to decrease in most G20 countries even if they increase in China (which is no small matter!). However, there is an even stronger trend showing non-CO2 emissions on the rise in almost all G20 countries, particularly in countries such as Canada, Saudi Arabia, France, or Turkey. While CH4 emissions come mainly from cattle, rice cultivation, coal mining, gas production or waste/wastewater management, N2O tend to be more concentrated in agriculture with about 75% of the total (e.g. manure and synthetic fertilizers). F-gases also contribute to rising non-CO2 emissions in some cases (i.e. fluorinated gases used for example in industrial processes including refrigeration and air conditioning). In the USA, the 2011-2016 rise of non-CO2 GHG came mainly from a steady increase in F-gases and an increase in CH4 from coal and gas production on 2010-2013.
* The size of the bubble is proportional to the CO2 emissions in 2016
Sources: Beyond Ratings, PBL NEAA (December 2017)
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