Loose Lips Sink Euro Bond Markets in Crisis: Cutting Research
Loose lips can cost Europe’s bond markets.
A European Central Bank paper released last week used 25,000 news media releases between January 2009 and October 2011 to investigate how much political communications affected sovereign bond yields during the region’s fiscal crisis.
The ECB study focused on public pronouncements on fiscal policy and state finances by officials. It found in the short term that certain types of commentary had a quantifiable effect on the spread between the bond yields of Greece, Ireland and Portugal over German bunds. The impact was biggest for Greece.
Policy makers at the regional level communicated more positively on average by using words such as “implement.” For those at the national level, the most-used word was “fail.”
The paper found that “at several points during the crisis, certain types of political communication may have added uncertainty rather than certainty to market perceptions,” said economists Marion Salines and Gabriel Glockler of the ECB, along with Thomas Gade of the Danish central bank and the Bundesbank’s Steffen Strodthoff.
“Unconstructive and inconsistent communications can have real and tangible effects on countries, their financing conditions and by extension on their populations, as well as on the cohesion of the euro area,” they said.
The research also found that the potential for confusing communication is “structurally higher” in the euro region because central bank bailouts are harder in the bloc; there are 17 national discourses, governments and policies; and because of the complexity of regional policy making.
“The absence of clearly defined centers of political authority (e.g. there is no ‘euro area treasury secretary’) leads to a dispersion of the focus of market attention and concomitantly more ‘noise’ in political communication,” they said in the report.
Communications could be made more effective although “under no circumstances should the open political discourse in Europe’s liberal democracies be subordinated to the ostensible necessities of sovereign debt markets,” the report concluded.
* * *
The chance that the Federal Reserve will send long-term interest rates surging when it pulls back stimulus is less than in the past because of its improved communications, according the Fed Bank of Cleveland.
With some investors concerned that long-term interest rates may jump more than is justified when monetary policy is tightened, economist Pedro Amaral looked over the past three decades at periods when the Fed’s benchmark began to rise: April 1983, April 1987, February 1994, July 1999 and July 2004.
He found that markets were most likely to be roiled when they were surprised by policy actions or economic developments. That’s what happened in 1994, when yields on 10-year Treasury bonds increased over 200 basis points in a year.
By contrast, in 1987 and 2004 the Fed’s benchmark rose the same as or even more than in 1994 with less adverse consequences for bond markets, Amaral said. The difference may be that forecasters better predicted the behavior of Treasury notes and bills in 2004 than they did a decade earlier, he said.
“While in the 2004 episode forecasting errors were relatively small and stable, in the shorter 1994 episode this was not the case,” Amaral wrote. “Forecasting errors were increasing and ended up being relatively large, as yields consistently surprised on the upside.”
When the Fed comes to pull back this time, its use of communications could help “avoid credit market turbulence” by ensuring markets aren’t surprised by the Fed’s actions, he said. The Fed has set inflation and unemployment parameters to govern shifts in its benchmark rate, allowing investors to better form expectations of future rates. It also produces more economic forecasts to help align the market and the Federal Open Market Committee.
Still, being transparent is easier said than done, as the recent rise in long-term rates shows, Amaral said. The episode began after Fed Chairman Ben S. Bernanke signaled that the central bank may start winding down its quantitative easing later this year.
“This is testimony to the high degree of uncertainty surrounding these expectations,” said Amaral. “The hope is that such uncertainty is coming mostly from the inherent randomness associated with future economic activity and that the committee is actually helping to reduce it with its new tools and recent actions.”
* * *
Emerging markets are set to become bigger players in the international investment scene after having been the main recipient of foreign investment.
In a July 3 report, HSBC Holdings Plc economist Madhur Jha said that even given the recent wobble in developing economies, they will still dominate the world over the next four decades and their success will lead to greater exports of capital.
Another reason to bet on such a trend is that since these economies run current account surpluses, emerging markets will look for greater returns on the proceeds than the traditional U.S. Treasury notes.
Manufacturing, mining and trade-related services currently dominate the outward spending of China and Brazil, Jha said. India’s is biased toward financial services, reflecting its strength as a services hub.
* * *
A surge in the status of the Massachusetts Institute of Technology as a location for economic research following World War II may be tied to its embrace of Jewish academics.
In a paper released last month, E. Roy Weintraub of Duke University noted that the Cambridge, Massachusetts university emerged from “nowhere” in the 1930s to become one of the three or four most important sites for economic research by the middle of the 1950s.
A reason is that after World War II, MIT welcomed Jewish economists more than any other elite rival, such as future Nobel laureates Paul Samuelson and Robert Solow, said Weintraub. He noted that through last year, 29 of the first 68 Nobel laureates in economics were Jewish.
“The department and university were remarkably open to the hiring of Jewish faculty at a time when such hiring was just beginning to be possible at Ivy League universities,” wrote Weintraub. “Any history of MIT’s emergence among economics departments that left out any mention of its unique openness to hiring Jewish faculty in the first post-war decade would be” impoverished.
* * *
The effect of government budget cuts can be twice as large in crisis times, according to Portugal’s central bank.
A July 2 working paper reviewed fiscal multipliers, which shows how much an economy changes when government budgets shift. It found the multiplier can be two in a period of turmoil, when governments are consolidating their spending. That is almost twice the 1.2 of normal times.
“In general, fiscal instruments that generate stronger downward inflationary pressures, such as those mostly depressing aggregate demand vis-a-vis aggregate supply, have their short-run multipliers further magnified in crisis times,” the Bank of Portugal paper said.
* * *
Negative political campaigns force men to the ballot boxes, while women respond more to positive messages.
So says a study by Vincenzo Galasso of the University della Svizzera Italiana and Tommaso Nannicini of the University of Bocconi. It focused on 2011 municipal elections in Milan and eligible voters were split into three groups. Two of them were exposed to the incumbents advertising but to different campaigns from the opponent with either a positive or negative tone. A control group received no information.
While the male turnout increased amid negative advertising, women voted more for the opponent when exposed to the positive campaigns. The results of the study published by the London-based Centre for Economic Policy Research suggested politicians take gender into account when deciding communication strategies.
To contact the reporter on this story: Simon Kennedy in London at email@example.com
To contact the editor responsible for this story: Craig Stirling at firstname.lastname@example.org