NEW YORK – The Federal Reserve will hold its most important policy meeting this week since, well, its last one in July and until its next one in October.
That’s the pitch whenever the Federal Open Market Committee gets together, which happens every six weeks or so. And the line is just as true as ever. But a significant shift may be at hand for the Fed and the world’s other major central banks.
Monetary policy, as practiced for the past four decades, might be changing. With interest rates at historic lows, and below zero percent in much of the world, its ability to continue to guide and sustain the world’s advanced economies could be nearing an end. Fiscal policy – that is, government spending and taxing decisions – could take on greater importance.
That’s the message from Mario Draghi following his penultimate meeting presiding over the European Central Bank this past week. Japan could also be ready to expand its fiscal stimulus after nearly three decades with the world’s lowest interest rates, which have failed to end that nation’s near economic stagnation and deflation.
As for the US, its fiscal policy already is easy. The federal government just announced that its deficit for the 11 months of fiscal 2019 was more than $1 trillion. To be sure, that excludes September, the final month of the fiscal year, in which Uncle Sam typically runs a surplus. But the shortfall still equals more than 4 percent of gross domestic product, a deficit normal during recessions, but not in the 11th year of an expansion.
Across the pond, the ECB’s official monetary moves this past week consisted of a 10-basis-point (0.1 of a percentage point) cut in its policy rate to minus 0.50 percent, with “tiering” to exempt some banks from the consequent charge on their deposits at the ECB; a new round of refinancing operations; and a resumption of the ECB’s asset purchases of up to 20 billion euros ($22.15 billion) a month.
But that wasn’t the real point, writes Bill Blain, strategist at Shard Capital in London, in his ever-witty Morning Porridge missive.
“Europe is heading down a new road – the fiscal super-highway. Draghi confirmed it when he called it ‘Time for Fiscal Policy to take Charge,’ challenging governments with ‘fiscal space to act in an effective and timely manner.’ It was a perfect setup for his successor, Christine Lagarde, who has but one role: to ensure that the politics of Europe fall in with fiscal stimulus.”
And rather than worrying that more eurozone borrowing portends a debt crisis, ECB purchasing should hoover up the bonds sold to cover deficits, he adds. “Strip it to the core and you could argue all that’s really happening is the ECB is printing lots of money for European states to juice their economies.”
That’s preferable to negative interest rates, which act as a tax on banks, contend John Ryding and Conrad DeQuadros of RDQ Economics.
And it’s also preferable in the minds of most German savers. A recent story on the ECB in the German daily newspaper Bild was headlined, “Count Draghila is sucking our accounts dry.” It pictured the ECB chief as the infamous vampire.
The RDQ team notes that Germany is considering establishing an agency to finance infrastructure and climate-change spending without violating deficit rules, which Chancellor Angela Merkel said would be money “well invested.” That shows an important change in thinking after five years of Berlin budget surpluses.
Japan also might be moving to fiscal stimulus, according to Steven Ricchiuto, US chief economist at Mizuho Securities.
While Prime Minister Shinzo Abe had been considering a second round of consumption taxes, Ricchiuto had eye-opening conversations with clients on a recent Tokyo trip about modern monetary theory, a hot topic in economics and financial circles.
Basically, MMT would allow fiscal deficits to be financed by the central bank, with the constraint being when this debt monetization boosts inflation near an unacceptable level. With the main alleged economic problem now being that inflation is too low, that constraint is absent.
The federal-funds futures market on Friday placed an 89.6 percent probability on a 25-basis-point cut in the Fed’s key interest rate this past week. President Donald Trump would like the Fed to go to zero, or below, to get the economy running hot while his tariff wars cool global trade and worsen uncertainty.
The Fed already has stopped shrinking its balance sheet and will be buying more Treasury securities with reinvested interest and maturing issues. A resumption of active buying, aka quantitative easing, would seem likely in the next recession. All of which sounds as close to modern monetary theory as “damn” is to swearing.
Is that what gold is anticipating?
Behind the stock market’s climb to within a hair of its record-high lay dramatic shifts beneath the surface of the major indexes. Moreover, this reversal of fortune coincided with a dramatic backup in the bond market. The two appear related.