Lots of things happening this week, including various central bank meetings and non-farm payrolls.

Bloomberg quotes an analyst talking about the “credibility problem” faced by a central bank “promising to be irresponsible” in order to raise inflation expectations, in the context of the BoJ. It strikes me that, in the US, this credibility problem has been much less of an actual problem than people suppose. It’s true that forward guidance has failed to raise inflation expectations above about 2.5%; but it has managed (until recently, at least) to keep them up. And the market has had a tendency to follow the Fed’s lead in terms of economic expectations. We can see this in the way that forward guidance kept long-term interest rates low even as inflation expectations rose: the coherent interpretation is that the market accepted a) that the economy was weak enough to justify low rates for a long time and b) that rates being low for a long time would be enough to generate enough growth in the economy to keep inflation around 2%. So the credibility problem has not been as much of a problem as some assume. It would be a problem if one wanted inflation expectations to rise significantly above 2% (which is something I might try if I was chairman of the Fed), but just getting them up to 2% or so is something of an achievement.

This piece of musing leads me on to an apparent problem in the interpretation of current markets. In response to Bernanke’s recent pronouncements, long-term interest-rates have risen, but equities also remain strong. This is consistent with a view that the US economy is finally normalising after years of “new normal” (excuse the facetious contrast) conditions — i.e. that self-sustaining growth will require the central bank to begin to raise interest rates in the coming few years. That view is consistent with the decoupling of the behaviour of the S&P 500 from real interest rates, which has been a post-crisis feature of policy-driven markets. BUT, at the same time, breakeven inflation has fallen all along the curve, something that would be suggestive of future economic weakness. That is the apparent problem. However, with a little thought, we can see that this is consistent with the foregoing considerations. Inflation expectations had got rather high, but after Bernanke’s comments, fell sharply. The 5-year breakeven is presently just under 2%, and the 10-year a little over. It seems that markets had been pricing a doveish Fed; it is now pricing a Fed that will respond in the usual way to self-sustaining growth, by raising interest rates to keep inflation at about 2%.

There is the potential for a trade here, if one thinks that the US is not, in fact, exiting its long depression and returning to a pre-crisis mode of growth. I am not sure whether there is a good basis for thinking that. On the one hand, scepticism about the end of the depression has been a good bet since 2008; on the other, it will have to end some time, and the pickup in residential investment and continued improvement in the labour market suggest that the economy is slowly healing. One to ponder further.

Mr. Kuroda has said that the planned sales tax increase would have little effect on the economy. That strikes me as rather implausible. Presumably, as a central banker, Kuroda is worried about the market “losing confidence” (the very phrase makes me feel slightly queasy — “confidence” is not a model, for heaven’s sake!) in Japanese government debt.

This reminds me of something I have been thinking about recently. For several years, fiscal authorities around the world have fretted about the dangers of fiscal action to deal with the aftermath of the GFC. Now, it seems, Mr. Kuroda is fretting about fiscal action to end Japan’s long stagnation. This seems to me to be straightforwardly daft, for two reasons. First, years of austerity (or, in the case of Japan, failure to go the whole hog on stimulus) have resulted in persistently weak economies and hence an increase in debt/GDP ratios. To a first approximation, the debt/GDP ratio depends on GDP growth, not the government deficit. Second, this kind of thinking represents a failure to understand the inherent uncertainty of the future. There are very real problems today that policy-makers ought to be addressing. They fail to do so, because there are worried about future costs. But future costs are always a matter of great uncertainty; the only reason to treat them as having the same solidity as current problems is if they are either i) obviously bigger than the costs of current inaction, which is not the case here, or ii) you are a wimp, preferring to keep your hands clean than to risk taking action. I suspect that far too many policy-makers fall under that description.

Let’s not forget to keep an eye on Italian politics. The Supreme Court is set to rule on Mr. Berlusconi’s appeal against his conviction for tax fraud. If his appeal fails, he could be sent to jail (or, as a pensioner, given community service). According to the FT, various things might then happen. Hawks in the People of Liberty have suggested a mass resignation of MPs. I cannot see what this would achieve. The party could pull its ministers out of coalition, and in due course precipitate an election (probably; the president would try to prevent this, but might have no choice). One assumes that the point of this would be either to enable a new People of Liberty-led government to change the law to get Mr. Berlusconi off, or to capitalise on his supposed victimisation to improve its chances in an election, or to precipitate an election at a favourable time on this pretext. That last idea seems most plausible, and it suggests that further political upheaval in Italy becomes more likely the further ahead People of Liberty is in the polls.


  • UK M4 0.1% MOM Jun. The trend remains anaemic.
  • UK net lending to individuals continued to bump along at a slow pace.
  • Revised UoM sentiment hit a new post-crisis high of 85.1 b.e.
  • Tokyo core CPI 0.3% YOY a.e. Jul. Culture & recreation and furniture & household items were the largest negatives; Fuel and transportation the largest positives.
  • Core durable goods orders 0% MOM Jun d.e.
  • UK prelim. GDP 0.6% QOQ, 1.4% YOY. This is a relatively strong number for the post-crisis period. Agriculture, production, construction and services all contributed positively, with construction edging up from a long-term low hit in Q1. The economy remains 3.3% below its 2008 peak.