As we saw in the news item The difficult exit from cheap money, central banks around the world have been operating an extremely loose monetary policy since the beginning of 2009. Their interest rates have been close to zero and trillions of dollars of extra money has been injected into the world economy through various programmes of quantitative easing.
For the past few months the Federal Reserve has been purchasing bonds under its most recent programme dubbed QE3, and thereby increasing narrow money, by $85 billion per month. Since the start of its QE programme in 2009, it has pumped around $2.8 trillion of extra money into the US and world economies. This huge increase in money supply has boosted the demand for assets worldwide and world stock markets have risen. Much of the money has flowed into developing countries, such as India, and has acted as a boost to their economies.
Once the US economy is growing strongly again, the aim is to taper off, and ultimately end or even reverse, the QE programme. It was expected that the Fed would decide to start this tapering off process at its meeting on 18 September – perhaps reducing bond purchases initially by some $10 billion. (Note that this would still be an increase in money supply, just a slightly smaller one.) Over the past few days, US bond prices have been falling (and yields increasing) in anticipation of such a move.
As it turned out, the Fed decided to delay tapering off. It will continue with its assets purchase programme of $85 billion per month for the time being. The reason given was that the US economy was still too fragile and needed the monthly injections of money to stay at the current level.
Normally it might be expected that the announcement of a more fragile recovery would cause the US stock market, and others worldwide, to fall. In fact the opposite occurred, with investors relieved that the extra money, which allows extra asset purchases, would continue at the same rate.
But this then raises the question of just what will be the effect when tapering off does actually occur. Will stock markets then go into a tailspin? Or will they merely stop rising so fast. That depends very much on the role of speculation.
Webcasts
Bernanke’s Own Words on Asset Purchases, Economy Bloomberg (18/9/13)
Bernanke: Fed to delay bond tapering PBS Newshour on YouTube (full speech plus questions) (18/9/13)
No tapering announced by Fed CNBC on Yahoo Finance (18/9/113)
The impact of US stimulus moves at home and abroad BBC News, Stephanie Flanders (18/9/13)
Is the upturn reaching Americans? BBC World, Stephanie Flanders (17/9/13)
Shares hit high as Federal Reserve maintains stimulus BBC News, Stephanie Flanders (18/9/13)
US Fed decision to delay tapering was a relief ET Now (India), Bimal Jalan (19/9/13)
Articles
Federal Reserve surprises markets by delaying QE tapering The Telegraph, Katherine Rushton (18/9/13)
Federal Reserve delays QE tapering: the full statement The Telegraph (18/9/13)
Q&A: What is tapering? BBC News (18/9/13)
Fed delay is no reason to celebrate The Guardian, Larry Elliott (19/9/13)
Federal Reserve tapering decision has baffled the markets The Guardian, Larry Elliott (19/9/13)
Taper tiger The Economist (21/9/13)
Everything You Need to Know About the Fed’s Decision Not to Taper QE3 The Atlantic, Matthew O’Brien (18/9/13)
Fed’s dovish turn leaves Wall Street economists mulling taper timing: poll Reuters, Chris Reese (18/9/13)
Good news and bad news from the Fed BBC News, Stephanie Flanders (19/9/13)
Is the Fed frightened of its shadow? BBC News, Robert Peston (19/9/13)
The Federal Reserve and Janet Yellen face a tough task with insufficient tools The Guardian, Mohamed A. El-Erian (14/10/13)
Questions
- Why might a slowing down in the increase in US money supply cause asset prices to fall, rather than merely to rise less quickly?
- Why has the US QE programme led to a rise in asset prices overseas?
- Distinguish between stabilising and destabilising speculation. Which type of speculation has been occurring as a result of the US QE programme?
- How has QE affected unemployment in the UK and USA? How is the participation rate and the flexibility of labour markets relevant to the answer?
- Explain the following two statements by Stephanie Flanders and Robert Peston respectively. “The market conditions argument has a circularity to it: talk of tapering leads to higher market rates, which in turn puts the taper itself on hold.” “The Fed simply hinting that less money would be created, means that there will be no reduction in the amount of money created (for now at least).”
- Why have US long-term interest rates, including mortgage rates, risen since May of this year?
- What impact have higher US long-term interest rates had on economies in the developing world? Explain.
The growth of emerging economies, such as China, India and Brazil brings with it both good and bad news for the once dominant countries of the West. With growth rates in China reaching double digits and a much greater resilience to the credit crunch and its aftermath in these emerging nations, they became the hope of the recovery for the West. But, is it only benefits that emerge from the growth in countries like China?
Chinese business has grown and expanded into all areas, especially technology, but countries such as the USA have been reluctant to allow mergers and takeovers of some of their businesses. Notably, the takeovers that have been resisted have been in key sectors, particularly oil, energy and technology. However, it seems as though pork is an industry that is less important or, at least, a lower risk to national security.
Smithfield Foods is a US giant, specialising in the production and selling of pork. A takeover by China’s Shuanghui International Holdings has been approved (albeit reluctantly) by the US Committee on Foreign Investment. While the takeover could still run into obstacles, this Committee’s approval is crucial, as it alleviates concerns over the impact on national security. The value of the deal is some $7.1bn, including the debt that Shuangui will have to take on. While some see this takeover as good news, others are more concerned, identifying the potential negative impact it may have on prices and standards in the USA. Zhijun Yang, Shuanghui’s Chief Executive said:
This transaction will create a leading global animal protein enterprise. Shuanghui International and Smithfield have a long and consistent track record of providing customers around the world with high-quality food, and we look forward to moving ahead together as one company.
The date of September 24th looks to be the decider, when a shareholder meeting is scheduled to take place. There is still resistance to the deal, but if it goes ahead it will certainly help other Chinese companies looking for the ‘OK’ from US regulators for their own business deals. The following articles consider the controversy and impact of this takeover.
US clears Smithfield’s acquisition by China’s Shuanghui Penn Energy, Reuters, Lisa Baertlein and Aditi Shrivastava (10/9/13)
Chinese takeover of US Smithfield Foods gets US security approval Telegraph (7/9/13)
US clears Smithfield acquisition by China’s Shuanghui Reuters (7/9/13)
Go-ahead for Shuanghui’s $4.7bn Smithfield deal Financial Times, Gina Chon (6/9/13)
US security panel approves Smithfield takeover Wall Street Journal, William Mauldin (6/9/13)
Questions
- What type of takeover would you classify this as? Explain your answer.
- Why have other takeovers in oil, energy and technology not met with approval?
- Some people have raised concerns about the impact of the takeover on US pork prices. Using a demand and supply diagram, illustrate the possible effects of this takeover.
- What do you think will happen to the price of pork in the US based on you answer to question 3?
- Why do Smithfield’s shareholders have to meet before the deal can go ahead?
- Is there likely to be an impact on share prices if the deal does go ahead?
Turkey has experienced rapid economic growth in recent years and has attracted large inflows of foreign capital. The chart below illustrates how growth in real GDP in Turkey in most years since 2000 has considerably exceeded that in the OECD as a whole (click here for a PowerPoint). As you can see from the chart, growth in Turkey over the period has averaged 4.5%, while that in the OECD has averaged just 1.8%.
Indeed, Turkish growth has been compared with that of the BRICs (Brazil, Russia, India and China). However, like the BRICs, Turkey has been experiencing slowing growth in the past few months. Indeed, the slowdown has been especially marked in Turkey.
In recent years Turkey has benefited from large inflows of foreign capital. Partly these were direct investment flows, encouraged by a large and rapidly growing internal market, boosted by a rapid expansion of consumer credit, and also by a growing export sector. But to a large extent, especially in recent years, there has been a large rise in portfolio and other investment inflows. This has been encouraged by a large increase in global money supply resulting from policies of quantitative easing in the USA and other developed countries.
But the economic climate has changed. First investors have become worried about the conflict in Syria escalating and this impacting on Turkey. Second Turkey’s large financial account surpluses have allowed it to run large current account deficits and have maintained a high exchange rate. Third the tapering off and possible reversal of quantitative easing have led to recent outflows of finance from various countries perceived as being vulnerable, including Turkey.
The effect of this has been a depreciation of the Turkish lira and upward pressure on inflation. The lira has fallen by 14% since the beginning of 2013 and by nearly 7% since the beginning of August alone.
The question is whether the supply side of the Turkish economy has become robust enough to allow the country to ride out its current difficulties. Will foreign investors have sufficient faith in the long-term potential of the Turkish economy to continue with direct investment, even if short-term financial inflows diminish?
Articles
Turkey’s economy faces uncertainties amid possible military intervention in Syria Xinhua, Fu Peng (29/8/13)
Turkey may cut 2014 growth target to 4% Turkish Daily News (8/9/13)
Turkish lira at record low, threatening growth Daily News Egypt (7/9/13)
Turkish lira may need higher interest rates to escape emerging markets rout Reuters, Sujata Rao and Seda Sezer (20/8/13)
Turkey Economic Crisis: Crises from Both Sides Wealth Daily, Joseph Cafariello (9/8/13)
Western financial prescription has made Turkey ill The Observer, Heather Stewart (1/9/13)
Turkish Deputy PM Babacan calm amid economic fluctuations Turkish Daily News (8/9/13)
The Fragile Five BBC News, Linda Yueh (26/9/13)
Data
Economic growth rates (annual) for Turkey, Brazil, Russia, India and China: 2000–13 IMF Economic Outlook Database (April 2013)
Quarterly growth rates of real GDP for OECD countries and selected other countries and groups of countries OECD StatExtracts
Turkey and the IMF IMF
Turkey: data World Bank
Links to Turkish Official Statistics Offstats
Country statistical profile: Turkey OECD Country Statistical Profiles
Spot exchange rate, Turkish Lira into Dollar Bank of England
Questions
- Why has the Turkish economy experienced such rapid growth in recent years and especially from 2010 to 2012?
- Why has Turkish growth slowed over the past year?
- Why has “Western financial prescription made Turkey ill”
- Why has the Turkish lira depreciated? What has determined the size of this depreciation?
- What are the beneficial and adverse effects of this depreciation?
- Why must any surplus on the combined financial and capital accounts of the balance of payments be matched by a corresponding deficit on the current account?
- How is a tapering off of quantitative easing likely to impact on developing countries? What will determine the size of this impact?
- Istanbul has lost its bid to host the 2020 Olympic Games? How is this likely to affect the Turkish economy?
The rate of growth in India has fallen to its lowest level since the first three months of 2009 – the period when many countries were plunging into recession. Although the annual rate was still 4.4% in Q2 2013 (a rate most Western governments would love to achieve!), it had averaged 8.2% from 2003 to 2007 and 9.5% from 2010 to 2011 (see).
And the rupee has been falling in value (see chart below). The exchange rate of the rupee to the dollar has depreciated by 21% since the start of the year and by 14% since the beginning of August (click here for a PowerPoint of the chart). This has pushed up the price of imports and raised fears that inflation, already approaching 10%, will rise.
There have also been concerns about the health of India’s banking sector, with worries over the possible rise in bad loans.
One result of all these factors is that the confidence of investors has been shaken. Bond prices have fallen and so too have share prices. The Mumbai Sensex index fell by 11.5% from 22 July to 27 August. Worried about possible capital flight, the Indian government imposed capital controls on Indian residents on 14 August. It has, however, since ruled out limiting the outflow of funds by foreign investors.
The following articles and videos look at the causes of the current economic problems and what can be done about them.
Webcasts
India’s sliding economy Aljazeera (24/8/13)
Economic woes grow for Indians as rupee continues to slide BBC News, Sanjoy Majumder (30/8/13)
What is behind the Indian economy’s fall from grace? BBC News, Yogita Limaye (30/8/13)
Indian rupee: How onions reflect health of economy BBC News, Nitin Srivastava (30/8/13)
The rise and fall of India’s economy NDTV (20/8/13)
Is the Indian economy heading for a doom? NDTV, Dr Arvind Virmani, Adi Godrej, P N Vijay, Sanjay Nirupam and Prakash Javadekar (20/7/13)
Can Rajan stabilise India’s economy? FT Video, Stuart Kirk and Julia Grindell (7/8/13)
Articles
India in trouble: The reckoning The Economist (24/8/13)
PM warns of short term shocks, attacks BJP for stalling Parliament The Economic Times of India (31/8/13)
External global factors led to rupee slide: Manmohan in Lok Sabha Hindustan Times (30/8/13)
India seeks allies to defend rupee as growth skids to four-year low Reuters, Manoj Kumar and Frank Jack Daniel (30/8/13)
Rupee charts in uncharted territory Reuters, Saikat Chatterjee and Subhadip Sircar (30/8/13)
Indian Prime Minister Says Rupee Crisis Will Only Make Country Stronger Time World, ilanjana Bhowmick (30/8/13)
Is India in danger of another crisis? BBC News, Linda Yueh (8/8/13)
India’s GDP shows continuing slowdown BBC News (30/8/13)
Slowest India Growth Since 2009 Pressures Singh to Support Rupee Bloomberg, Unni Krishnan (30/8/13)
Questions
- Why has the rupee fallen in value so dramatically? Is there likely to have been overshooting?
- What are the economic consequences of this large-scale depreciation? Who gain and who lose?
- What factors are likely to affect the rate of growth in India over the coming months?
- Why is the Indian economy more vulnerable than many other Asian economies?
- What economic policies are being pursued by the Indian government? How successful are they likely to be?
Tight fiscal policies are being pursued in many countries to deal with high public-sector deficits that resulted from the deep recession of 2008/9. This has put the main onus on monetary policy as the means of stimulating recovery. As a result we have seen record low interest rates around the world, set at only slightly above zero in the main industrialised countries for the past 4½ years. In addition, there have been large increases in narrow money as a result of massive programmes of quantitative easing.
Yet recovery remains fragile in many countries, including the UK and much of the rest of Europe. And a new problem has been worries by potential investors that loose monetary policy may be soon coming to an end. As the June blog The difficult exit from cheap money pointed out:
The US economy has been showing stronger growth in recent months and, as a result, the Fed has indicated that it may soon have to begin tightening monetary policy. It is not doing so yet, nor are other central banks, but the concern that this may happen in the medium term has been enough to persuade many investors that stock markets are likely to fall as money eventually becomes tighter. Given the high degree of speculation on stock markets, this has led to a large-scale selling of shares as investors try to ‘get ahead of the curve’.
Central banks have responded with a new approach to monetary policy. This is known as ‘forward guidance’. The idea is to manage expectations by saying what the central bank will do over the coming months.
The USA was the first to pursue this approach. In September 2012 the Fed committed to bond purchase of $40bn per month (increased to $85bn per month in January 2013) for the foreseeable future; and record low interest rates of between 0% and 0.25% would continue. Indeed, as pointed out above, it was the ‘guidance’ last month that such a policy would be tapered off at some point, that sent stock markets falling in June.
The Fed has since revised its guidance. On 10 July, Ben Bernanke, the Fed Chairman said that monetary policy would not be tightened for the foreseeable future. With fiscal policy having been tightened, QE would continue and interest rates would not be raised until unemployment had fallen to 6.5%.
Japan has been issuing forward guidance since last December. Its declared aim has been to lower the exchange rate and raise inflation. It would take whatever fiscal and monetary policies were deemed necessary to achieve this (see A J-curve for Japan? and Japan’s three arrows).
Then on 4 July both the Bank of England and the ECB adopted forward guidance too. Worried that growth in the US economy would lead to an end to loose monetary policy before too long and that this would drive up interest rates worldwide, both central banks committed to keeping interest rates low for an extended period of time. Indeed, the ECB declared that the next movement in interest rates would more likely be down than up. Mario Draghi, the ECB president said that the ending of loose monetary policy is ‘very distant’.
The effect of this forward guidance has been to boost stock markets again. The hope is that by managing expectations in this way, the real economy will be affected too, with increased confidence leading to higher investment and faster economic growth.
Update (8/8/13)
With the publication of its August 2013 Inflation Report, the Bank of England clarified its approach to forward guidance. It was announced that Bank Rate would stay at the current historically low level of 0.5% ‘at least until the Labour Force Survey headline measure of unemployment has fallen to a threshold of 7%’. In his Inflation Report Press Conference opening remarks, Mark Carney, Governor of the Bank of England, also stated that:
While the unemployment rate remains above 7%, the MPC stands ready to undertake further asset purchases if further stimulus is warranted. But until the unemployment threshold is reached the MPC intends not to reduce the stock of asset purchases from the current £375 billion.
Nevertheless, the Bank reserved the right to abondon this undertaking under cirtain circumstances. As Mark Carney put it:
The Bank of England’s unwavering commitment to price stability and financial stability is such that this threshold guidance will cease to apply if material risks to either are judged to have arisen. In that event, the unemployment threshold would be ‘knocked out’. The guidance will remain in place only if, in the MPC’s view, CPI inflation 18 to 24 months ahead is more likely than not to be below 2.5%, medium-term inflation expectations remain sufficiently well anchored, and the FPC has not judged that the stance of monetary policy poses a significant threat to financial stability that cannot otherwise be contained through the considerable supervisory and regulatory policy tools of the various authorities. The two inflation knockouts ensure that the guidance remains fully consistent with our primary objective of price stability. The financial stability knockout takes full advantage of the new institutional structure at the Bank of England, ensuring that monetary and macroprudential policies coordinate to support a sustainable recovery. The knock-outs would not necessarily trigger an increase in Bank Rate – they would instead be a prompt for the MPC to reconsider the appropriate stance of policy.
Similarly, it is important to be clear that Bank Rate will not automatically be increased when the unemployment threshold is reached. Nor is 7% a target for unemployment. The rate of unemployment consistent with medium-term price stability – a rate that monetary policy can do little to affect – is likely to be lower than this. So 7% is merely a ‘way station’ at which the MPC will reassess the state of the economy, the progress of the economic recovery, and, in that context, the appropriate stance of monetary policy.
The articles in the updated section below consider the implications of this forward guidance and the caveat that the undertaking might be abondoned in certain circumstances.
Articles
Q&A: What is ‘forward guidance’ BBC News, Laurence Knight (4/7/13)
Forward guidance crosses the Atlantic The Economist, P.W. (4/7/13)
ECB has no plans to exit loose policies, says Benoit Coeure The Telegraph, Szu Ping Chan (25/6/13)
ECB issues unprecedented forward guidance The Telegraph, Denise Roland (4/7/13)
Independence day for central banks BBC News, Stephanie Flanders (4/7/13)
The Monetary Policy Committee’s search for guidance BBC News, Stephanie Flanders (16/7/13)
The Monetary Policy Committee’s search for guidance (II) BBC News, Stephanie Flanders (17/7/13)
Bank of England surprise statement sends markets up and sterling tumbling The Guardian, Jill Treanor and Angela Monaghan (4/7/13)
Forward guidance only works if you do it right Financial Times, Wolfgang Münchau (7/7/13)
Fed’s Forward Guidance Failing to Deliver Wall Street Journal, Nick Hastings (15/7/13)
Talking Point: Thoughts on ECB forward guidance Financial Times, Dave Shellock (11/7/13)
Forward guidance in the UK is likely to fail as the Fed taper approaches City A.M., Peter Warburton (12/7/13)
Forward guidance more than passing fashion for central banks Reuters, Sakari Suoninen (11/7/13)
Markets await Mark Carney’s ‘forward guidance’ The Guardian, Heather Stewart (17/7/13)
Beware Guidance The Economist, George Buckley (25/7/13)
Articles for update
The watered down version of Forward Guidance Reuters, Kathleen Brooks (8/8/13)
Clarity Versus Flexibility at the Bank of England Bloomberg (7/8/13)
Mark Carney’s guidance leaves financial markets feeling lost Independent, Ben Chu (8/8/13)
Bank links interest rates to unemployment target BBC News (7/8/13)
Mark Carney says forward guidance should boost economy BBC News (8/8/13)
The Bank’s new guidance BBC News, Stephanie Flanders (7/8/13)
Uncertainty over BoE guidance lifts sterling to 7-week peak Reuters, Spriha Srivastava (8/8/13)
Bank of England’s guidance is clear, say most economists: Poll The Economic Times (8/8/13)
Britain’s economy: How is it really doing? The Economist (10/8/13)
Markets give thumbs down to Mark Carney’s latest push on forward guidance The Guardian, Larry Elliott (28/8/13)
Carney’s guidance on guidance BBC News, Stephanie Flanders (28/8/13)
Webcasts and podcasts for update
Inflation Report Press Conference Bank of England (7/8/13)
Interest rates to be held until unemployment drops to 7% BBC News, Extracts of Statement by Mark Carney, Governor of the Band of England (7/8/13)
Bank of England links rates to unemployment target BBC News (7/8/13)
Mark Carney: Financial institutions ‘have to change culture’ BBC Today Programme (8/8/13)
Bank of England’s Mark Carney announces rates held BBC News. John Moylan (7/8/13)
Central Bank Statements and Speeches
How does forward guidance about the Federal Reserve’s target for the federal funds rate support the economic recovery? Federal Reserve (19/6/13)
Remit for the Monetary Policy Committee HM Treasury (20/3/13)
Bank of England maintains Bank Rate at 0.5% and the size of the Asset Purchase Programme at £375 billion Bank of England (4/7/13)
Monthly Bulletin ECB (see Box 1) (July 2013)
Inflation Report Press Conference: Opening remarks by the Governor Bank of England (7/8/13)
MPC document on Monetary policy trade-offs and forward guidance Bank of England (7/8/13)
Monetary policy and forward guidance in the UK Bank of England, David Miles (24/9/13)
Monetary strategy and prospects Bank of England, Paul Tucker (24/9/13)
Questions
- Is forward guidance a ‘rules-based’ or ‘discretion-based’ approach to monetary policy?
- Is it possible to provide forward guidance while at the same time pursuing an inflation target?
- If people know that central banks are trying to manage expectations, will this help or hinder central banks?
- Does the adoption of forward guidance by the Bank of England and ECB make them more or less dependent on the Fed’s policy?
- Why may forward guidance be a more effective means of controlling interest rates on long-term bonds (and other long-term rates too) than the traditional policy of setting the repo rate on a month-by-month basis?
- What will determine the likely success of forward guidance in determining long-term bond rates?
- Is forward guidance likely to make stock market speculation less destabilising?
- Is what ways is the ‘threshold guidance’ by the Bank of England likely to make the current expansionary stance of monetary policy more effective?
- Is 7% the ‘natural rate of unemployment’? Explain your reasoning.
As we saw in the news item The difficult exit from cheap money, central banks around the world have been operating an extremely loose monetary policy since the beginning of 2009. Their interest rates have been close to zero and trillions of dollars of extra money has been injected into the world economy through various programmes of quantitative easing.
