Hartar Blog

The yield curve is becoming flatter. The difference between the 10-year and 2-year government bond is now approaching 1%. The yield curve tends to get flatter when the economy reaches the end of an expansion phase and it is many times seen as a predictor of future recessions. But interest rates are not what they used to be. If short-term interest rates are stuck at zero, all the movements in the yield have to come from long-term interest rates. This is the opposite than what we have seen in previous cycles where all the action has come from short term rates. The 2-year rate is not quite zero and has been moving recently, so an interesting question is whether the yield curve is once again driven by movements in short-term rates. Not quite. Let's calculate the correlation between changes in the slope  of the yield curve (measured as 10 year minus 2 year rates) and the changes in the 2 year rate. The correlation [calculated over a 3 year window] is plotted below.   If the 10 year...

The recent disappointing performance of the world economy has been labelled as the "new mediocre" by Christine Lagarde , the "new reality" by Olivier Blanchard and the "new normal" by many others. How mediocre is global growth? The answer to this question heavily depends on the way we measure world GDP. Aggregating national GDPs can be done in two ways: using market exchange rates or using PPP (purchasing power parity). Because PPP puts larger weights on emerging markets and because these countries have shown faster growth rates in recent decades, the two measures have been diverging over time and now they offer a very different picture of the state of the world economy. Below I plot world real GDP growth rates (smoothed by taking a 7-year centered average) measured at market exchange rates and PPP (both data are produced by the IMF). During the early 80s both measures were identical because emerging markets did not grow faster than advanced economies (plu...

While the ECB and Bank of Japan are exploring negative interest rates, the US Federal Reserve is preparing us for a slow and cautious increase in short-term interest rates. Long-term rates remain at very low levels and inflation expectations have come under pressure and also remain below what they were a few months or years ago. And as this is going on markets are trying to figure out if they like low or high interest rates. And even if they decide that they like low rates, are negative rates too low? In all these debates there seems to be an unusual amount of what economists call money illusion or lack of understanding of the difference between nominal and real interest rates. This confusion, in my view, is partly motivated by the communication strategy of central banks that seem to obsess with the asymmetric nature of their inflation targets (for both the ECB and US Fed, inflation targets are defined as close but below 2%) and are not clear enough on their final goal and its timing. ...

The ECB just announced a further reduction in interest rates, extended its QE program by increasing the rate at which buys assets, beefed up the TLTRO program and extended its horizon. It all sounds like good news and many of these actions had been expected in the last meeting of 2015 and they did not happen. Markets reacted very positively on announcement but later, after the press conference, they went down to levels that were significantly below where they were before the announcement. It is always hard to comment on why markets react in a certain way to monetary policy announcements but I must say that watching the press conference I learned about the state of desperation and possibly confusion of the ECB, which was not very reassuring. It might not be their fault, this is life when central banks hit the zero lower bound on interest rates and there is very little they can do. And the available tools are not easy to communicate to markets and the general public. An extra 20 billion ...

If the US or the Eurozone entered a recession this year, a few macroeconomic variables would look very different relative to previous recessions. 1. The Yield curve would be very steep. Unlike in any previous recession when the yield curve was flat or inverted. 2. The real federal funds rate (or the ECB real repo rate) would be extremely low and would be at a level similar to that of the beginning of the expansion. Unlike in previous recessions where the real central bank interest rates was high relative to the beginning of the expansion. 3. And nominal central bank interest rates would be stuck at zero so there will be no room to lower them in response to the recession. Unlike in previous recessions where nominal interest rates came down by about 4-7 percentage point (this is also true for real interest rates, see previous chart). So maybe this tells us that a recession is not about to happen. But if it is, the lack of space to implement traditional monetary policy tools should be a b...

An interview with Hyun Song Shin, economic adviser and head of research at the BIS, reposted in the BIS web site  reminds us of the strange and heterodox views that the BIS (and others) have about the behavior of inflation. The views run contrary to most of what we all teach about inflation. They can only be understood if one has a very special and radical view on what determines inflation and are supported by a unique reading of the data. You probably need to read the whole interview to understand what I mean but here is a summary of the new BIS theory of inflation: 1. Inflation is a global phenomenon, not a national one. Monetary policy has very little influence on inflation, demographics and globalization are much more relevant factors. 2. The idea that monetary policy affects demand and possibly inflation is a "short-term" story that is too simple to understand the recent behavior of inflation. 3. Deflation is not that bad. The Great Depression is a special historical eve...

In most advanced economies business cycles can be well characterized by a succession of long expansion phases that are interrupted by short recessions. Given this pattern it is sometimes natural to think about the length of expansions as a key feature that describes the business cycle. While other variables matter (such as the depth and length of recessions), in the case of the US and to some extent in the case of European countries, the parameter that has changed the most across cycles is the length of the expansion phase. In the case of the US (using the NBER business cycle dates ), in the post-WWII period expansions have lasted from 12 months in the expansion ending in 1981to 120 months in the expansion ending in 2001. The current expansion is already 77 months long, longer than the previous expansion of 2001-2007. While counting months is not a good way to forecast the timing of the next recession it is at least a reminder that there is another recession waiting for us in the not-s...

It will soon be eight years since the US Federal Reserve decided to bring its interest rate down to 0%. Other central banks have spent similar number of years (or much longer in the case of Japan) stuck at the zero lower bound. In these eight years central banks have used all their available tools to increase inflation closer to their target and boost growth with limited success. GDP growth has been weak or anemic, and there is very little hope that economies will ever go back to their pre-crisis trends. Some of these trends have challenged the traditional view of academic economists and policy makers about how an economy works. Some of the facts that very few would have anticipated: - The idea that central banks cannot lift inflation rates closer to their targets over such a long horizon. - The fact that a crisis can be so persistent and that cyclical conditions can have such large permanent effects on potential output. - The slow (or inexistent) natural tendency of the economy to adj...

Ken Rogoff in the Financial Times argues that the world economy is suffering from a debt hangover rather than deficient demand. The argument and the evidence are partly there: financial crises tend to be more persistent. However, there is still an open question whether this is the fundamental reason why growth has been so anemic and whether other potential reasons (deficient demand, secular stagnation,…) matter as much or even more. In the article, Rogoff dismisses calls for policies to stimulate demand as the wrong actions to deal with debt, the ultimate cause of the crisis. As he argues, given that government expenditures have kept expanding (he uses the number for France at 57% of GDP) it is hard to argue in favor of more spending. But there is a perspective that is missing in that logic. The ratio of debt or government spending to GDP depends on GDP and GDP growth cannot be considered as exogenous. Assuming that the path of GDP is independent of the cyclical stance of the economy ...

Martin Wolf in today's Financial Times discusses the reasons for low interest rates and suggests some interesting scenarios for the years ahead. I agree with most of what he says but I have doubts about the role that he assigns to central banks. Let me start with the arguments with which I agree 100%. The logic of the Bank for International Settlements that low interest rates are the outcome of central banks managing to keep interest rates artificially low for decades is "wildly impossible". And the main reasons are that we have no economic model (or evidence) that suggests that central banks are able to manipulate real interest rates for decades and we do not either have any model (or evidence) that supports the idea that a central bank policy of low interest rates will not generate substantial inflation. As Martin Wolf argues, any explanation for low interest rates has to start with some version of the savings glut hypothesis. Economic, demographic and social changes ha...

Robert Shiller on the New York Times argues that the stock market is expensive by historical standards using the cyclically-adjusted price earnings ratio (CAPE) that he has made popular through his writings since the late 1990s. There is no doubt that the CAPE ratio for the US stock market is high by historical standards. Using Shiller's estimates it stands around 26 today, clearly above the historical average of about 17. What a higher CAPE means is that you are paying more for the same earnings. Earnings' growth could, of course, be different in the future. They might be lower because potential GDP growth is slowing down but they might be higher as profits as a share of GDP increases. If we assume the same number just for simplicity, a higher CAPE means that investors should expect a lower return if they buy the stock market today compared to an average year in the past. What does it mean for the future price of the stock market? Shiller concludes that maybe we will see the ...

The agreement between Greece and its Euro partners is full of very detailed policies to be approved by the Greek government in the coming week. How did we end up in a situation where the domestic policies of a Euro country are decided by other countries? I recently wrote a paper on the European reform agenda where I had a discussion on the role of Europe in the reform process. Here are some of what I wrote in the paper which is very appropriate for what we just witnessed over the last 24 hours. Historically Europe has served as a catalyst for reform in some of the least-advanced EU economies. Through the imposition of requirements to join certain European initiatives it has fostered enough social consensus around the need for compromises. As an example, it worked well to transform and standardize the macroeconomic institutions of European countries, especially when it comes to monetary policy and inflation. But these dynamics are not always productive. Reform is ultimately a domestic ...

The IMF published yesterday a preliminary analysis on the debt sustainability of the Greek government. The timing of the publication, a couple of days ahead of the referendum, has triggered a variety of interpretations of the conclusions. The Greek government has quickly jumped to argue that the results confirm that government debt in Greece is not sustainable and a substantial haircut is needed. Is the interpretation of the Greek government correct? Yes and no. The IMF analysis suggests that under reasonable assumptions on growth and interest rates for Greece, it is very difficult to imagine a path of primary budget surpluses that makes the current situation sustainable. This is what the Greek government says and in that sense it seems that the IMF is providing empirical support to their claims. However, the analysis is full of other subtleties that do not warrant this quick conclusion and that in some cases contradict the views of the Greek government. First, the report makes it clea...

The Eurozone and Greece are going through the last hours of a negotiation to ensure release of additional funds from the previous agreement and possibly setting the basis for the next one. The leaked details of the latest Greek proposal and the Eurozone counterproposal is full of details and discussions around technical issues (for example, whether the pension reform is effective from October 31 or July 1st). But what the technical discussions reveal is a negotiation that can only lead to an outcome that will not satisfy any of the parties. Reading between the lines of the technical details we see the Eurozone asking Greece for a strong package of front loaded fiscal measures many of which are exactly the ones the Greek government wanted to avoid as they go against the electoral platform under which they were elected. It would be very easy to criticize Germany, Brussels (and the IMF) for failing to see that we are possibly doing again the same mistakes as in previous agreements and tha...

The debate about who is responsible for the low level of interest rates that has prevailed in most economies over the last years heated up when Ben Bernanke wrote a series of blog posts on what determines interest rates. He argued, once again, that it is the global dynamics of saving and investment the one that created a downward trend in interest rates starting in the mid 90s and that it accelerated as a result of the crisis. In his story, central banks are simply reacting to economic conditions rather than driving the interest rate (always refreshing to see a former central banker explaining how powerless central banks are). What Bernanke described can be interpreted as a decrease in what economists called the natural real interest rate. There are, however, those who have a very different interpretation of the persistent low levels of interest rates. They see central banks as the main drivers of this trend and they think about current levels of interest rates as being artificially l...

One more round of negotiations between Greece and the rest of is European partners to seek a last-minute solution before the Greek government runs out of money. Negotiations could end up going in any direction. Greece is unlikely to score a massive win but it could buy itself some time if there is agreement around a reasonable set of reforms that are to be implemented over the coming months. Reforms that could be sold domestically very differently from the way they are presented in Brussels. What Greece really wants out of these negotiations is straightforward: a restructuring/reduction of its current debt that allows them to survive over the coming years with a primary balance in (small) surplus. This would mean that their pressure is gone and and that they can implement any policies they want without worrying about new loans as long as they can keep a primary surplus, which might be feasible given the current state of the budget. In return it will be easy to promise reforms that can ...