Bloomberg reports that a member of Japan’s parliament — and, apparently, a former “adviser” to George Soros, whatever that means — has warned that Japan faces hyperinflation, and that a “bond bubble” will burst if the government fails to raise the consumption tax as planned, as investors “lose confidence” in JGB’s.

I know it should not, but it always surprises me that people continue to believe this stuff. It comes down to the difference between models and reality. Clearly, this chap has some kind of model that says that these things can occur. But what is the model for? It is for understanding reality. In reality, are there any instances of countries with floating exchange rates with debt denominated mostly in their own currency suffering “losses of confidence” in their bond markets? Are there instances of their suffering hyperinflation? Some countries in the Eurozone have seen apparently self-sustaining increases in bond yield, but they do not have floating exchange rates or debt denominated in their domestic currency (because they are in a single currency). There have been instances of hyperinflation in recent times — Zimbabwe, or various ex-Soviet republics in the early 1990s — but these have been associated with political breakdown, not developed-world-style extraordinary monetary policy or high debt resulting from prolonged economic weakness. So, very well, this chap has a theory — but what facts is it supposed to explain?

Asked to explain the ECB’s forward guidance, Mario Draghi said: “We want markets to see our reaction function.” He then said that the assessment expressed in the forward guidance would remain the same as long as inflation remained “subdued”.

It strikes me that this is not a great way of putting it. How low is “subdued”. Since the inflation target is “below, but close to, 2%”, the maximum for “subdued” inflation could be anywhere from, say, 1% to 1.8%. So the word “subdued” doesn’t give very much information on the reaction function, and cannot logically be taken as telling the market that the ECB is less hawkish than it might previously have supposed — which must surely be the point of forward guidance as far as Mr. Draghi is concerned.

However, this kind of pedantic analysis failed to capture the essence of the Fed’s forward guidance when it was first adopted. Forward guidance actually seems to have been very effective in the US (although its effectiveness at keeping rates low along the curve has diminished with the adoption of data-based guidance, as I forecast in January). The market has seemingly taken the Fed’s pronouncements more seriously than the Fed itself, probably because they recognise that it would be politically difficult (and damaging to its “credibility”) for the Fed to reverse the forward guidance without strong evidence that its previously-expected rate path was inappropriate.

In other words, forward guidance means that the market expectation of future rate hikes will not rise linearly with improving economic forecasts; rather, there will be a threshold for future economic strength above which interest rates would be expected to rise by more than was stated in the forward guidance.

A couple of political observations.

Mr. Berlusconi’s conviction was upheld. He will probably serve some kind of sentence (house arrest or community service are considered likely). I still cannot see why it would be rational for the PDL to pull out of the coalition on account of this ruling, unless it is clearly leading in the polls (the PD and PDL appear to be roughly neck and neck, according to However, Bloomberg quotes a political analyst who suggests another possibility: that divisions within the PD over working in coalition with the PDL will become more pronounced, and could cause a major headache for Mr. Letta.

The Republican reaction to Mr. Obama’s proposed deal on corporate tax is hardly surprising. As one commentator said (and I may be paraphrasing), if Mr. Obama came out in favour of breathing, the Republican caucus in the House would start holding its breath. I see Mr. Obama’s move as a matter of positioning before the coming budget and debt-ceiling showdowns. His recent speeches should be seen in the same light. On the subject of that battle, Bloomberg has two interesting observations. First, that the chairman of the House Appropriations Committee favour an extension of the current budget for two months to November, when the debt limit is likely to be hit; in other words, Republicans may want to lump all of the negotiations together. This would contrast with their tactics at the start of the year, when they separated automatic tax increases from automatic budget cuts (and allowed the latter to occur) and from the budget (on which a deal was negotiated). Perhaps the reason is that there is no automatic change to be exploited this time around. Second, Mitch McConnell himself has said that Senate Republicans will force a government shutdown unless funding for Obamacare is withdrawn. That is a pretty strong statement, especially since the Democrats will never agree.

Of course, it is a mistake to put too much weight on what politicians say. As Calculated Risk points out, the Republicans are “bluffing into the nuts” (that is, in poker, bluffing against an opponent who holds the best available hand, given the shared cards on the table). If they actually force some kind of default or government shutdown, their brand is likely to be heavily tarnished in the eyes of the public. According to the polls, they (rightly) took much of the blame for the near-miss in 2011.


  • Initial claims 326k b.e. Following revisions, this is a new post-crisis weekly low.
  • ISM PMI 55.4 b.e. and rose sharply.
  • Vehicle sales fell back a little after two months of increases to a post-crisis high, a.e., Jul.
  • BoE held rates. Latest projections and response to the Chancellor’s request for its assessment of the use of thresholds and forward guidance will be published on 7 Aug.