Tag Archives: monetary policy

Richard Koo gives a “Post-QE forecast: sunny, cloudy, or stormy?”

Summary: Prosperity, perhaps even survival, in the 21st century might require learning which experts we should listen to. In economics its a short list, if we limit it to people who have understood large aspects of the great recession and the aftermath.  Richard Koo certainly deserves to make that short list. Here he tells us what to expect next.



“Post-QE forecast for leading economies:
sunny,cloudy, or stormy?”

Richard Koo, Chief Economist
Nomura Research Institute

25 March 2014



{People} were roiled by Fed Chair Janet Yellen’s first press conference last Wednesday, where she suggested a rate hike could come as soon as next spring. The fact that {people} reacted so much led some in the media to question her communication skills, given her predecessor’s skill in this area.

{People} also appear to have been surprised and disappointed that the supposedly dovish Ms. Yellen indicated the possibility of a tightening of policy. “This wasn’t supposed to happen” seemed to be the general reaction.

Marketsand media unaware that US is in QE trap

Nevertheless, it was easy enough to predict that the Fed would have to move in this direction when it began normalizing policy after years of quantitative easing. The media’s criticism of her dialog and {people’s} complaints about the lack of further accommodation tells us that most of them have yet to realize the US economy has fallen into the QE trap. Their ignorance is of far greater concern, in my view.

{People} and members of the media simply do not understand that an economic recovery in a country that has undertaken QE is going to be very different from a recovery in a country that has not.

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Japan leads us into a new future, taking the next step in the great monetary experiment

Summary: A first step to understanding comes from appreciating the wonders before us. Recognition of extraordinary events that lie before us. Not unique events (those are seldom seen), but event of unusual magnitude. Old Faithful, not the usual steam kettle on the stove. Today we look at one such, one of the greatest experiments ever: sustain large-scale monetary stimulus.

In “Forbidden Planet” a great distant civilization — far away, long ago — built a planetary-scale machine to grant their every wish. It didn’t end well for them, but they deserve high marks for the boldness and scale of the project. Today economists are attempting something less ambitious, but still bold beyond any precedents.

ATLAS experiment

In the basement of the Federal Reserve


Size of central bank balance sheets for the major nations (2014 IMF estimate):

  • China: $4.8 trillion, 49% of GDP
  • Japan: $2.0 trillion, 39% of GDP
  • UK: $0.7 trillion, 25% of GDP
  • US: $4.2 trillion, 24% of GDP
  • EU: $3.0 trillion, 23% of GDP

These are mind-blowing numbers, become familiar to us in the five years since the crash.

Combined with artificially low interest rates (near-zero in all of the above but China), the major nations have sought to restore growth using extreme and unconventional monetary policy measures. The first phase — first aid to stabilize their financial systems during the crash (2008-09) were a success. The results since then, using monetary policy for extended treatment, remain unknown until the experiment concludes and monetary policy returns to normal.

As with any bold experiment, economists will learn much from the results. If successful, it will be a new world. Economic policy of the 21st century will look nothing like that of the post-WW2 era, any more than the dark nighttime cities of Victorian London resemble its brightly lite 21st century version. Future downturns — and even more so with future crashes — will be met with tsunamis of newly printed cash. Perhaps we’ve built a monetary savior, like the discovery of antibiotics.

We’ll know when the experiment is concluded. So far the results are cloudy; we’ll have to ask again later.

Japan leads the way

Haruhiko Kuroda

Haruhiko Kuroda

Japan is the cutting edge of this experiment, going boldly to where no nation has gone before. While other nations look to slow the monetary engines, they’re revving them up even more.

Bank of Japan Governor Haruhiko Kuroda said there were “no limits” to what the central bank can do if it saw the need to adjust monetary policy in the future, signaling readiness to expand stimulus further if risks threatened its price target {2% inflation}. … He also said it was “not as if there weren’t any steps left” for the BOJ to take if it were to ease again, countering views held by some market participants that having delivered a massive stimulus last year, the BOJ had no tools left to deploy.

— Interview on 13 March with Japan’s Jiji news agency, as reported by Reuters

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What happens if the economy hits some rocks? Will the Fed stop the taper?

Summary: The first phase of the great monetary experiment was guaranteed pleasure. Whatever the results, monetary stimulus feels great. Then comes the difficult process of withdrawing the stimulus. “Tapering”, as its called by economists (and, coincidentally, by heroin addicts). How much damage will be cause? How much pain? Today we have advice about what to expect from someone with more experience at this game than most economists.

The Taper


One fascinating about political economy (the intersection of politics and economics) is the how frequently people believe with total certainty things that are not so.

After Obama took office in 2009 many people “knew” that the Keynan socialist would inexorably expand the size of the government bureaucracy.  In fact the Federal government’s workforce is up only 3.7% in the five years since then (less than the population increase of 4.3%), and down 4.4% since the May 2011 peak (vs population up 2.0%).

Many people “knew” that the has been no recovery from the great recession. Many people still believe this, despite the slow improvement in almost every economy measurement of the US economy (how that recovery has been shared is a different question).

The common element of such stories: they are both comforting and conform to their biases. What do people know now about the next phase of the US economy’s story? What comforting stories do they tell us?

  • Most economists believe that there will be only a small cost (or impact) from the taper, and probably even from the larger process of normalizing (i.e., tightening) monetary policy (including raising interest rates) of which the taper is just the first phase.
  • Many people, especially on Wall Street, believe that at the first signs of turmoil the Fed will stop the tightening cycle, or even reverse it.

We can only guess at the first of these, the results of the great monetary experiment. My guess is that the process will be difficult. See Government economic stimulus is powerful medicine. Just as heroin was once used as a powerful medicine.

For an answer to the second we turn to one of Japan’s top economists, who draws upon lessons learned not only from US history, but also from Japan’s quarter-century struggle with similar problems. He believes that for good or ill the Fed will stop the normalization process only after a “huge plunge” in markets or large bank failures.


“Fed tapering and emerging market turmoil”

By Richard Koo (Chief Economist), Nomura
4 February 2014

Minor shocks from emerging economies will not deter Fed

The recent market turbulence began with a steep fall in the Argentine peso, which quickly put pressure on other emerging market currencies. Nevertheless, the Fed’s Federal Open Market Committee (FOMC) not only decided to push ahead with tapering but also made no mention of the emerging market turmoil in its official statement. I suspect this is because — as argued in my last report — the Fed’s main scenario is likely to involve reducing asset purchases by an identical amount at each FOMC meeting, following the practice of former Fed Chairman Alan Greenspan, who successfully raised the federal funds rate by 425bp {basis point} this way in the 2000s.

Raising the policy rate by 25bp at each FOMC meeting was so automatic and predictable that once the market understood what the Fed was trying to do, long-term interest rates were largely unaffected by the tightening. The yield on the 10-year Treasury note rose just 60bp throughout the entire tightening cycle in spite of more than 400bp in rate hikes.

Today’s FOMC, which fears nothing more than an “unwarranted” rise in long-term rates, seeks a repeat of that experience. In that sense, I think it is extremely unlikely to abandon its current approach because of moderate turbulence in domestic or overseas markets.

Side effects of ending mechanical tapering would outweigh benefits

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The easy way to understand unconventional monetary policy

Summary:  It’s difficult to describe the magnitude of the monetary policy experiments now running around the world, most especially in China, USA, and Japan. At the end are links to a dozen posts attempting to do so with words and numbers. Today we do it with pictures.

Money world


The monetary stimulus programs running around the world are in effect leaps into the future, leaps of a scale never before attempted, leaps beyond theory. Should they work the world will changed, for these tools — massive quantitative easing and extended periods of zero interest rates (ZIRP) — will be used again. And again.

How can I show you the fantastic nature of these experiments? How they move far beyond what’s been considered possible — even prudent — in the past. How their success would create a new world? And, most difficult, how the programs of each nation differ in scope and daring?

Let’s use picture to show this, as metaphors.

First, the below picture shows America’s monetary policy: five years of ZIRP and three rounds of quantitative easing — designed by the four hundred economists of the Federal Reserve System, using unconventional means to press conventional theory beyond its limits — to rekindle the power of the American economy.


Fusion and Dr Octavius


Second, we see Japan. They’ve had zero or near-zero interest rates since February 1999 (with intermissions), and several rounds of quantitative easing since March 2001 — attempts to re-ignite their economy since it flamed out in 1998. The latest is the three arrows of Abenomics (often described in different ways), announced by Prime Minister Shinzo Abe in December 2012.

  1. More fiscal stimulus, increasing the government’s deficit by 2% of GDP (to 13%).
  2. More monetary stimulus: doubling the money supply in 2 years to create 2% inflation.
  3. Structural reform — broad, deep, powerful (so far missing in action).

Abenomics is the desperate action of leaders who have tried everything in the playbook, and now tap unimaginable energies to unleash arcane regenerative forces that can revitalize Japan’s economy. They go beyond theory, a leap combining faith and science.

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A status report on the US economy. What can we expect in 2014?

Summary:  Today we have a quick look at the US economy. Where it’s at. Grading its performance. Where it’s going.


Economic Machinery

Unavailable today; but we have guesses


  1. The slow growth recovery
  2. Good news!
  3. Bad news!
  4. Perhaps very bad news: are we like Japan?
  5. The clock runs against us
  6. For More Information

(1)  The recovery: slow steady growth

Before looking ahead, let’s look back. In November 2012 the consensus estimate of 2013 real GDP was 2.3% (Wall Street Journal survey of economists). Based on the preliminary estimates of Q4 GDP, current estimate of 2013 GDP is 2%, as of Friday. That’s reasonably close.

Is 2% good or bad? Context matters.

  • 2% growth would be horrific for China with potential growth of 5% – 7%, per capita of $6,500.
  • The US has grown at 2.2% since 2010, only slightly below the Fed’s 2.2% – 2.4% estimate of long-term GDP growth (a slowing from the post-WW2 average). So 2% is a disappointing slowdown.
  • On the other hand, 2% is slow for a recovery, especially following the deepest recession since the 1930’s.

Worse, the trend of GDP has an ugly look. Real GDP might be stabilizing at a lower level of growth. For the second time. The first slowing was after 1980 (the oddly named “Reagan Revolution”).



But real GDP is not always the relevant number. In many ways we living in a nominal world. Profits, savings and many important factors require nominal growth. Unfortunately, the nominal graph looks similar to the graph of real GDP.

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The Economist recommends taking the easy path to inflation. But what if it’s closed?

Summary:  If the great monetary experiments underway in Japan and America succeed, then the world will change. Aggressive fiscal and monetary stimulus will become routine, even normal. For better or worse. Already the normalization process has begun by people unaware that in this new century the easy path to inflation has been closed, with as yet unknown consequences.

Money whirlpool

Christian Science Monitor, 8 November 2010



  1. The world has changed, yet they still dream of monetary magic
  2. About inflation
  3. The Boomers’ secret lust for inflation
  4. For more information


(1)  The world has changed, yet they still dream of monetary magic

QE3 will raise the Federal Reserve’s assets by almost 40% in its first year. Japan has adopted an even bolder strategy. One of the two arrows of the three arrows to Abenomics is doubling the money supply in two years in order to raise inflation to 2%. If these monetary experiments work, then the world will change. Already the yearnings for inflation, simmering since the crash (but expressed in euphemisms), are now expressed openly.

Secular stagnation: The second best solution“, The Economist, 21 January 2014  — Excerpt:

WITH a string of talks and op-ed columns, Larry Summers has revived discussion in the “secular stagnation” hypothesis. Income has become concentrated in the hands of groups, like reserve-accumulating foreign governments and the rich, with low propensities to consume, the thinking goes. That has generated excess saving and pushed down real interest rates until they are substantially negative at many durations. That, in turn, has made life very difficult for central banks, which have struggled to stoke up adequate demand with nominal interest rates wedged up against zero.

Mr Summers identifies three broad solutions to the problem.

  • One is to do nothing, or not much anyway, on the demand side. This is not a particularly attractive solution, as it implies a very long slump in which incomes are lower than they need to be, unemployment is higher, and the economy’s potential is eroding.
  • Another is to raise inflation expectations in order to reduce real, or inflation-adjusted, interest rates until demand is where we’d like it to be. This policy is not without its downsides …
  • The last option to address stagnation is to have the government soak up excess savings and boost demand through deficit-financed public investment.

The third option is quite clearly Mr Summers’ preferred course of action. And it is a very attractive option. It is a rare rich country that doesn’t have a list of infrastructure needs that could justifiably be addressed in the best of times. Pulling those off the shelf and taking them on amid rock-bottom interest rates and weak demand is a no-brainer. Unfortunately, governments are discinclined to seize these opportunities. That makes it very important to sort out the relative attractiveness of alternative solutions to stagnation.

My sense is that Mr Summers reckons the inflation strategy is not as easy to deploy successfully as I make it out to be. QE purchases focused on safe assets might have an ambiguous effect on the economy: boosting asset prices through portfolio balance effects but limiting lending growth by sucking up the supply of good collateral. And as Brad DeLong notes, high inflation could conceivably undermine the safe-asset status of some government securities. Meanwhile, central banks might not be comfortable mustering the bluster to convince markets that higher inflation is ahead. And if they did, increases in long nominal rates could create their own financial difficulties.

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Wagering America on an untested monetary theory

Summary: After years of quantitative easing, with the Fed starting to slow the third great wave, officials are breaking their facade of confidence to admit what many of us have long said. They do not know how QE works, or the effects of ending it. QE is an experiment, one of the greatest economic experiments of the modern era. That is the most important thing to know about QE, and the fact most carefully hidden (until now). We might find the next few years quite exciting. Here are two articles to help you understand, and so prepare.

Money world


“We don’t understand fully how large-scale asset purchase programs work to ease financial market conditions. Is it the effect of the purchases on the portfolios of private investors, or alternatively is the major channel one of signaling?”

— William Dudley (President, Federal Reserve Bank of New York), speech at the American Economic Association Annual Meeting, 4 January 2014

“The problem with QE is that it works in practice but it doesn’t work in theory.”
— Ben Bernanke, speech at Brookings Institute, 16 January 2014

“When you believe in things that you don’t understand, then you suffer. Superstition ain’t the way.”
– Stevie Wonder, “Superstition” (1972)

(1)  Weekly comment by John Hussman (former Prof Economics at U MI, portfolio manager of the Hussman Funds), 20 January 2014 — Excerpt (red emphasis added):

What FOMC officials are really saying is that aside from a very predictable effect on short-maturity interest rates, there is no mechanistic link between the monetary base and any other variables – financial or economic – that they are trying to control. There is a sense that creating more monetary base helps stocks advance, and that this contributes to economic confidence. What’s missing is a transmission mechanism that operates through identifiable banking and economic channels – other than promoting a speculative reach-for-yield and the psychological exuberance that accompanies a bull market.

The fact is that Treasury bond yields are above where they were when QE2 was initiated in 2010, and year-over-year growth in non-farm payrolls, civilian employment, real GDP and real final sales have at best done little but hover at the thresholds that have historically bordered expansion and recession. Good economic policy acts to ease constraints that are binding, and monetary policy can clearly be useful in that regard – particularly during liquidity crises when depositors are rushing for cash. At present, however, quantitative easing acts by massively loosening a constraint that is not binding at all, drowning the economy with idle bank reserves that aren’t even desired. That’s going to have negative consequences.

… Regardless of my objections to the course of monetary policy, I think the Fed’s intentions are good, and I share Janet Yellen’s concern for the unemployed. I just believe that there is no demonstrable mechanism that reliably links the actions of the Fed to the outcomes it seeks, and that the unintended effects are greatly underestimated.

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