Matt Nolan

Watch the curve: Thoughts for the RBNZ September MPS

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Tomorrow its more than likely the RBNZ will leave the official cash rate unchanged.  Following that a lot of people are going to say one of the following:

  1. Bah, the world is in crisis they should slash rates
  2. Bah, inflation expectations are elevated and CPI growth is high, they should be increasing rates

Or who knows, some people will probably say both.

Anyway, even if they leave the official cash rate unchanged this does not mean they would have done nothing – in truth even when they leave the OCR unchanged they may loosen monetary policy due to the seizing up in global financial markets.  They do this by changing their forecast for where the official cash rate will go:

Source (RBNZ)

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Matt Nolan

Papers on the old new financial crisis

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Brad Delong links to a number of interesting papers regarding the US/global financial crisis of 2007-2009.  I recommend the optional ones.

I’m not sure I completely agree that the bailing out of Bear Stearns made matters worse – but it was an interesting perspective.

In any case, its a good idea to try and understand what happened then – in order to figure out whether the debt crisis in Europe will lead to similar global pain.

IMO when Greece does default, who holds the associated liabilities is widely know – as a result, my hope would be that nothing will really happen.  With nothing happening, the rest of the world will just move on.  The risk is that Greek default actually knocks out a big bank (it looks less likely now that it will knock out a sovereign government – although that remains the big fear in Europe).  Fluffing around in Europe has kept credit conditions tight for at least 18 months longer then they would have been, in the absense of European debt issues – it is starting to feel like some people will have to accept some loses before this crisis can end, and some semblance of global confidence can return.

Matt Nolan

Sometimes TVHE does raise points

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Over at Money Illusion Scott Sumner states:

The recent Swiss devaluation has led to some interesting reactions in the blogosphere.  But one angle that I haven’t seen discussed is the relationship of the Swiss action and bubble theory.

Within an hour or two of the announcement we had said (in additional to the straight avoiding deflation argument):

Furthermore, it seems apparent that the Swiss National Bank views the current level of the currency as a bubble – people running to saftey see the Swiss Franc as attractive, and people who want to invest expect this to continue, leading to a self-fulfilling expectation driving up the value of the Franc.

Then when discussing the cap the next day we said:

I can understand why they did it, they felt there was an asset price bubble in their exchange rate – and they wanted to provide a lower focal point that traders could shift too (since expectations were driving the currency … note the increase in risk associated with intervention is also important).

TVHE is little, and doesn’t say much – but at least we picked up that angle immediately.  And so we’re going to claim it … do we get a high five

Matt Nolan

Will the Swiss event start a series of competitive devaluations?

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In so far as we believe monetary policy in most countries is “too tight” there could be a significant upside to the Swiss decision to set a minimum value on their Euro change rate – if currency intervention is copied by most other countries it will lead to a loosening in monetary conditions.

Scott Sumner hints at this, and its an issue we’ve discussed here before.  Although it is true that “not all countries can depreciate their currencies at once” they can devalue their currency relative to goods – they can create inflation.  If there are risks of deflation, or inflation expectations are below the central banks target, such intervention could be justified.

Now, when writing about the Swiss event I wasn’t quite as confident.  This was due to the fact that the Swiss actually went out and set a value on the currency – rather than just loosening policy.

I can understand why they did it, they felt there was an asset price bubble in their exchange rate – and they wanted to provide a lower focal point that traders could shift too (since expectations were driving the currency … note the increase in risk associated with intervention is also important).  But if everyone sets “targets” there is the risk that we get an exchange rate regime where this rate doesn’t respond to changing economic fundamentals – and given that economic fundamentals change constantly, this is a concern.

Matt Nolan

Swiss national bank “pegs” the currency: What’s it mean?

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With people running away from European banks, and global investors nervous, they have been moving swiftly towards “safe” assets – such as the Yen and the Swiss Franc.

There has been sustained intervention in these currencies since late-July, but now the Swiss National Bank has gone a step further – they have set a minimum exchange rate. [Marginal Revolution also discusses here]

So they’ve pegged their currency to the Euro!

Not quite – they’ve set a cap regarding how high strong currency can be against the Euro.  They’ve said in their statement that:

The current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development.

This is still, in a large part, consistent with an inflation targeting mandate – they have just said the following:  “be aware that we are going to print money and buy up foriegn currency until our currency is back at a level that is consistent with our inflation mandate” – they have just identified a level of the exchange rate that wouldn’t carry the strong risks of deflation they are currently experiencing.

Furthermore, it seems apparent that the Swiss National Bank views the current level of the currency as a bubble – people running to saftey see the Swiss Franc as attractive, and people who want to invest expect this to continue, leading to a self-fulfilling expectation driving up the value of the Franc.

Now I’m not the biggest fan of messing around with relative prices in this way – as it could just be that Europe is so far in the toilet that the weak Euro is telling us something … as a result, my preference would be for the Swiss to just print a whole lot of money and buy currency without setting an explicit “target” in the way they have (outside of stabilising inflation rates).

My CONCERN is that this will lead to further exchange rate management around the world – although not as dangerous as protectionism, I can still see nasty side effects from this.

The real problems are in Europe – and they need to sort them out.  However, given they won’t other countries are stuck introducing “second best” policies (with the potential for unintended consequences) which is sad.

In terms of NZ this means nothing – they are worried about an asset price bubble in currency markets due to people running to “low risk” currencies … we are the polar opposite 😉 .  Also they are worried about deflation, we aren’t.

Matt Nolan

Has monetary policy failed the world?

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There are two views of the long festering economic malaise that has hit the world – the view that monetary policy has done too little (read Sumner – I would put proponents of fiscal policy in the same camp) and the view that the world is re-adjusting to a structural shock and so has to undergo some drop in activity (read Kling).

Now, there is currently no way to really separate which view is right and which view is wrong.  But there is one thing we can keep in mind – during the Great Depression (which has been put down as a time when monetary policy failed) we saw inflation fall well below the Fed’s implied target … but this time they’ve kept things pretty close to where they were aiming.

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