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Draghi With Bernanke Vision Would Ease More: Cutting Research

Photographer: Simon Dawson/Bloomberg

Light trails made by a passing tram are seen in front of the European Central Bank's (ECB) headquarters in Frankfurt. If the ECB were to match the Bank of England’s analysis of economic threats, the appropriate policy rate for the euro area would be minus 3.8 percent. Close

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Photographer: Simon Dawson/Bloomberg

Light trails made by a passing tram are seen in front of the European Central Bank's (ECB) headquarters in Frankfurt. If the ECB were to match the Bank of England’s analysis of economic threats, the appropriate policy rate for the euro area would be minus 3.8 percent.

The European Central Bank would do “a lot, lot more” in terms of easing monetary policy if it mimicked the aggressiveness of foreign counterparts, says David Mackie, chief European economist at JPMorgan Chase & Co. (JPM)

Looking beyond the euro area to divine how easy monetary policy is elsewhere, Mackie used the Taylor Rule, an economic model that determines an optimal interest rate based on inflation and output. That suggests the appropriate rate for the U.S. is now zero -- about where the current benchmark is.

When the easing effect of the Fed’s bond-buying programs is included, he says, the policy rate is actually about minus 2.4 percent. Given Fed Chairman Ben S. Bernanke’s commitment not to change rates until inflation and employment goals are reached, the rate on the same basis could be minus 3 percent by late 2015 even if the more conventional Taylor Rule suggests plus 3.25 percent would be appropriate.

“There is thus a huge gap between what a standard Taylor Rule would suggest the appropriate policy rate should be in late 2015 and where the policy rate will be,” said Mackie, a former Bank of England economist.

Turning to the U.K. central bank, Mackie found the Taylor Rule suggests the appropriate benchmark rate is 1 percent, higher than the Bank of England’s current key rate of 0.5 percent. Meanwhile, the rate when asset purchases are accounted for is minus 3.75 percent.

By contrast, Mackie concludes that ECB President Mario Draghi and colleagues are far less aggressive than their colleagues in the U.S. and U.K. For the euro area, he estimates that allowing for the benchmark of 0.75 percent and the smaller- scale bond buying the ECB has undertaken, the effective policy rate is just minus 0.35 percent.

Both the ECB and the BOE kept their benchmark rates stable yesterday as the ECB predicted a deeper contraction this year and the BOE maintained its bond-purchase program.

If the ECB were to match the Bank of England’s analysis of economic threats, the appropriate policy rate for the euro area would be minus 3.8 percent. The ECB could achieve that by cutting its refinancing rate to 0.25 percent and buying another 1.9 trillion euros of assets, Mackie said.

“This analysis shows that the ECB could do a lot, lot more either in the present or in terms of commitments about the future and still remain broadly in line with what is going on elsewhere,” he wrote.

* * *

China’s anti-corruption drive could be enough to cut 1 percentage point off consumer inflation, according to Goldman Sachs Group Inc. (GS)

The crackdown by incoming President Xi Jinping on lavish entertainment of officials has led many expensive restaurants to cut prices and cancel the fees they charge for rooms, while lower-end restaurants are trying to take advantage of such business, said Goldman economist Yu Song and intern Maggie Wei in a March 6 report.

Over-ordering is also common at Chinese banquets and so less wasted food may also ease inflation, they said.

“Past crackdowns were typically short-lived,” the Goldman report said. “The current round may prove more sustainable, in particular because public attention on the issue is high and the increasing use of Internet provides more checks and balances than before.”

* * *

Policy makers seeking to gauge the potential of their economies should account for the financial cycle, says a study published by the Bank for International Settlements.

Doing so would have left them better placed to spot the recent global crisis by highlighting the economic risk of financial excess. Detecting an economy’s trend growth rate is key for central banks and governments, as they can learn at which point inflation will begin to pick up.

The recent credit crisis is a reminder that an economy can be growing on an unsustainable path when financial imbalances are building up, yet inflation remains low, said the Feb. 26 study. It was written by economists including Claudio Borio, deputy head of the monetary and economic department at the BIS in Basel, Switzerland.

The study found financial-cycle developments explain a “substantial portion” of movements in output, and so can help identify when economies are out of kilter. Accounting for financial developments and economic activity helps show when output is exceeding potential during asset booms regardless of the inflation environment.

For example, Borio and co-writers Piti Disyatat of the Bank of Thailand and the BIS’s Mikael Juselius showed that before the financial crisis, U.S. output was widely believed to be below or close to the perceived potential. Only after the turmoil was it recognized it had been above a sustainable level. Allowing for financial factors such as values of bonds and equities would have spotted that, said the study.

“Had policy makers relied on this information ahead of the crisis, they surely would have been in a better position to assess potential vulnerabilities as they built up,” the authors wrote. Ignoring the state of finance “is bound to provide less accurate estimates of potential output.”

* * *

The U.S. economy is not on the verge of a long-term demographic-driven stagnation because concerns of an aging population are “overblown,” said Deutsche Bank AG (DBK) economists.

Rebutting suggestions from economists including Robert Gordon of Northwestern University, the Deutsche economists led by Peter Hooper said in a March 5 report that aging will deduct an average of just 0.2 percentage points from annual economic growth through 2030, and maybe less given likely tax and entitlement policy changes.

The demographic shock is set to be more negative in Europe, China and Japan, they said.

The report also questions Gordon’s view that productivity gains from technology are expiring. The Deutsche economists said that although productivity has dropped since 2004, such measures are volatile. They noted a similar slowdown occurred around 1980 -- on the eve of a two-decade productivity boom.

“The conclusion for investors is that the U.S. remains very attractive on both an absolute and relative basis,” Hooper’s team said. “In other words, interest rates will not stay at record low levels for decades and investors should not stay away from U.S. equities or credit.”

* * *

The worst international recession since World War II has slowed the push of globalization.

An index produced by the KOF Swiss Economic Institute in Zurich published March 1 found globalization stagnated for a second year in 2010, the most recent year for which data are available.

The KOF index has tracked 187 countries since 1970 and is based on inputs such as trade and investment, the freedom of capital, the extent of political cooperation between countries and dissemination of information.

The standstill is visible worldwide. The index for the 34th- ranked U.S., for example, held at 74.76 for a second year in 2010 after peaking at 77.49 in 2007.

Belgium is the most globalized country in the world, followed by Ireland, the Netherlands, Austria and Singapore, the institute said. Lesotho and the Dominican Republic made the biggest steps up, jumping 22 places, while Samoa fell the most in a tumble of 32 positions.

* * *

Central banks could increase the returns on their foreign exchange reserves if they diversified them away from the bonds of major developed-market economies.

That’s according to the view of UBS AG (UBSN)’s asset management research arm, which calculates that reserves with bonds of one to three year duration currently have a yield of 0.20 percent, well below inflation in most economies.

While portfolios should be invested in liquid, low-risk government bonds and an amount kept back for monetary management purposes, reserves over a certain threshold should be used to secure extra returns and better manage risk, said UBS’s Massimiliano Castelli and Michele Gambera.

Economies with reserves between 10 percent and 30 percent of gross domestic product, such as Mexico or India, should limit diversification to fixed income assets including emerging market debt, they wrote. Those with higher stockpiles, such as China at 45 percent or Switzerland at 50 percent, should consider equities, they said.

* * *

The American Dream may be getting harder to live, according to the Federal Reserve Bank of San Francisco.

A study published in its March 4 Economic Letter suggested U.S. workers may not be as socially mobile as generally thought.

While American children readily become richer than their parents, they lack “relative mobility” -- the ability to change ranking in the income distribution compared with older generations.

For those born in the top or bottom fifths of incomes, “mobility is much more constricted, suggesting that birth circumstances play more of a role in lifetime outcomes,” said economists Leila Bengali and Mary Daly in the report.

“If the American Dream means rising in rank in the income distribution then the findings are not so encouraging,” they said. “In this case, an individual’s ability to reach the highest economic ranks of society seems at least partially determined by the income rank into which they were born.”

* * *

The news may be getting better for Europe’s crisis-stricken economies.

Societe Generale SA’s “newsflow” indicators count and analyze the number of newspaper articles related to economic strength. It has provided a guide to financial market movements and often leads trends by a few months, the French bank’s global asset allocation team said in a March 6 report.

The latest indexes suggested the economic news is improving in the euro-region peripheral economies. Spain’s reading is approaching 50, the level that indicates expansion because it signifies more positive news stories than negative.

Japan’s indicator is also now back above 50 following the December election of Prime Minister Shinzo Abe, while the U.S.’s is back below it at about 48. The global reading is about 45.

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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