It’s Friday again, my blog Lay Day, which means I fast track the blog entry in favour of other writing tasks. But one thing that is worth noting today (and I’m sort of catching up on recent events in my reading of them), is a speech that the Governor of the bank of Canada (its central bank) gave to the Empire Club of Canada in Toronto on December 8, 2015. The speech – Prudent Preparation: The Evolution of Unconventional Monetary Policies – was somewhat of a revelation given that it was coming from a central banker. Essentially, he admitted that monetary policy in the current situation was relatively ineffective and that expanding fiscal policy was the appropriate government strategy to address the cyclical downturn in non-government spending. He also disabused his audience of the notion that the current low growth environment was of a ‘structural’ nature. He said that the slow non-government spending growth was cyclical and reflected the reality of precarious private balance sheets and low confidence in the future. He channelled the writing of John Maynard Keynes, explicitly, which in itself, was a significant public recognition, especially by a central bank governor. So Canada has now elected a new government that is promised to increase the fiscal deficit to stimulate job creation and economic growth. It also has a central bank governor that implicitly is urging the government to use its fiscal policy capacities in that way. What a refreshing change!
As an aside, the Empire Club of Canada appears to be one of those anachronistic creations of the elite in Canada and it boasts “a membership comprised of some of Canada’s most influential leaders from the professions, business, labour, education and government”.
To hammer homeit’s past, its homepage advertisers its past speakers with a photo of none other than Winston Churchill, which I found most curious for a Canadian institution. Anyway, that’s not the topic of the blog today.
The Canadian central bank governor began by reminding the audience that:
A prominent Harvard University economics professor once suggested that the U.S. economy was headed for what he called “secular stagnation.” Extended periods of strong economic growth were no longer likely, he said, because of a chronic shortfall in demand.
I’m not referring to Harvard’s Professor Lawrence Summers, who holds this secular stagnation view today. Rather, I’m talking about Professor Alvin Hansen, who coined the phrase “secular stagnation” in 1938, during the Great Depression.
I thought that was interesting because I was working on my next book yesterday and was musing about the ridiculous Martin Feldstein (Harvard) and he is ‘expert’ prediction that Japan was about to experience rapidly increasing interest rates as a consequence of the on-going fiscal deficits. See below.
Anyway, back to the Governor’s speech.
He noted that Alvin Hansen was wrong for a number of reasons, but:
… an important ingredient was the revival of what John Maynard Keynes famously described as “animal spirits.” During the Depression, consumer and business pessimism was pervasive. Once confidence revived, pent-up demand was unleashed and self-sustaining growth returned.
I thought the reference to John Maynard Keynes was very pointed because for the last, maybe, three decades, prior to the GFC, his name mud.
In his 1999 book – Hard Heads, Soft Hearts: Tough-minded Economics For A Just Society – Alan Blinder said that by:
… about 1980, it was hard to find an American macroeconomist under the age of 40 who professed to be a Keynesian. That was an astonishing turnabout in less than a decade, an intellectual revolution for sure.
The academic departments had more or less purged the Keynesians from their ranks as Monetarism emerged dominant and evolved into more extreme free-market variations. I was still a student in 1980 and found very few opportunities to work my way into the Academy once I had graduated. Somehow, a path was made but, as now, there were very few non-orthodox young economists coming through. That is the topic for another blog though.
The Governor suggested that “the global situation today” is, in many ways, similar to the situation that policymakers confronted in the 1930s.
He said that just as recovery from the Great Depression was a lengthy process, “recovering from a shock like the global financial crisis can be a long drawn-out process”.
He said that recovery required that “consumers and businesses repair their balance sheets and rebuild their confidence in the future”.
Please read my blog – Balance sheet recessions and democracy – for more discussion on this point.
In that sense, he concluded that the problem is “a cyclical issue, not a secular one, although the cycle is proving to be longer than usual”.
That is also a significant statement to make given that the mainstream emphasis is always on so-called ‘structural reform’, which is a convenient smokescreen to avoid mainstream economists facing the reality that when non-government spending growth is insufficient, the only solution is for fiscal deficits to increase to support overall spending and growth.
A cyclical issue means that it is a spending problem rather than a unit cost or skills mismatch problem. It also means that the unemployment is of an involuntary nature and the unemployed are largely powerless to improve their situation.
The Governor said that recovery will only come at “such time as Keynes’s animal spirits, which have been crushed over the past seven years, revive”.
Again, a significant statement.
As a matter of context, he noted that the Canadian economy was beset with “excess capacity” and declining growth. It was undergoing a difficult transition – “a complex and lengthy adjustment to lower resource prices” – which requires a rebalancing so that “the non-resource economy” can take over as the growth engine.
In that sense, much of what he says is also relevant, specifically to Australia. But of course, as you will see, his comments really are relevant to all nations at present.
He went on to address the issue – again one of these mainstream narratives – that if “the economy was hit with another major negative shock” that policymakers would have “very little room to manoeuvre”, given that central bank policy rates are near zero (at the “effective lower bound”).
The mainstream economists have been mounting this case for some time now to push their claim that government policy interventions can no longer be of benefit to the economy unless they take the form of increased deregulation of the financial and labour market and massive cuts in government spending.
Of course, they exclude any government spending from the cuts that might be of benefit to themselves or the corporate interests that they take succour from.
The Governor outlined a series of non-interest-rate policy levers that the central bank has at its disposal to manipulate spending in the economy when interest rates are at their effective lower bound.
It was here that things became interesting.
He said that:
Another lesson we’ve learned from the global experience is that while unconventional monetary policies can help stimulate the economy, there may be limits to their impact … so we can’t be cavalier about how much more room to manoeuvre we have. Further, there is evidence that consumers and businesses respond less to interest rate declines when interest rates are already very low. And there is evidence that their responsiveness is also lower when confidence is low and they are trying to reduce debt. I expect that few of us find this to be surprising.
And then he said it:
Fundamentally, economists have long been aware that the effectiveness of monetary policy has its limits once interest rates reach very low levels. As Keynes noted as he watched the Great Depression unfold, fiscal policy tends to be a more powerful tool than monetary policy in such extreme circumstances. It may sound ironic, but the circumstances under which it may be appropriate to consider unconventional monetary policies are also those under which fiscal policy tends to be most effective.
As a central banker, he couldn’t really take this any further, lest he be accused of making overtly political statements. I know that principle hasn’t stopped other central bankers from interfering with the policy design of democratically elected governments, particularly in Europe.
But as a general principle, central bankers make cryptic comments when they are treading on the political terrain.
Given that cautionary bias, it is clear that the Canadian central bank governor was providing support to the newly-elected Canadian government to expand fiscal policy (as a cyclical intervention) and use the government’s currency-issuing capacity to rebuild non-government sector confidence and help the economy transition from the collapse in global commodity prices.
It seems like it will be a good time ahead for Canadians. They have elected a Liberal government which is openly stated as part of their campaign promises that they will increase the fiscal deficit over the next several years to improve Canada’s public infrastructure and to support faster job creation.
They also seem to have a central bank governor who understands that monetary policy, especially now, is relatively ineffective – relative to fiscal policy.
And, that governor is not afraid to publicly state that fiscal policy is an appropriate and effective counter-stabilisation tool for governments to use when non-government spending is weak.
The Canadians, at least, that is a major and refreshing break through amidst all of the misinformation that comes out of the mainstream academic economists and the financial press that act as their mouthpieces. (If you are living in the US or visiting there, you can browse grocery needs on mobile friendly Publix Weekly Ad.)
Feldstein makes a fool of himself
I last specifically wrote about this economist in this blog – Martin Feldstein should be ignored.
On January 17, 2013, he published an Op Ed article on the Project Syndicate home page – The Wrong Growth Strategy for Japan. The fact that this organisation chooses to publish the likes of Feldstein tells you a lot about it, but that is another story.
In the 2013 Op Ed in question, Feldstein wrote that:
Japan’s new government, led by Prime Minister Shinzo Abe, could be about to shoot itself in the foot. Seeking to boost economic growth, the authorities may soon destroy their one great advantage: the low rate of interest on government debt and private borrowing. If that happens, Japanese conditions will most likely be worse at the end of Abe’s term than they are today.
At the time the “interest rate on Japan’s ten-year government bonds … [was] … less than 1% – the lowest in the world, despite a very high level of government debt and annual budget deficits”. Which should have told him something but it didn’t.
He claimed that:
Japan’s government is able to pay such a low rate of interest because domestic prices have been falling for more than a decade, while the yen has been strengthening against other major currencies. Domestic deflation means that the real interest rate on Japanese bonds is higher than the nominal rate. The yen’s rising value raises the yield on Japanese bonds relative to the yield on bonds denominated in other currencies.
But because the Abe governemnt had “demanded that the Bank of Japan pursue a quantitative-easing strategy”, Feldstein predicted that inflation would accelerate because the yen would depreciate and drive up import prices.
His second prediction was that the Japanese government would only be able to continue selling bonds “if their nominal yield is significantly higher than it has been in the past”.
In turn, this would “increase the budget deficit and the rate of growth of government debt”, which would tempt the government “to rely on rapid inflation to try to reduce the real value of its debt”.
Fear of that strategy could cause investors to demand even higher real interest rates.
The combination of exploding debt and rising interest rates is a recipe for economic disaster.
So is pretty clear that Feldstein expected bond yields to rise significantly along with inflation and declining exchange rate.
The facts are as follows:
1. The fiscal deficit in Japan continues to rise.
2. The yield on 10-year Japanese government bonds has fallen well below 1 per cent since Feldstein wrote his article. They are now around 0.3 per cent, and have been falling consistently since 2006.
3. Inflation in Japan remains low and stable.
4. The yen has depreciated but has had zero effect on bond yields.
Music – Perfidia
This is what I have been listening to this morning while I have been working. Tomorrow night my band has been hired for a private xmas function in Melbourne and the organisers asked us if we would do requests.
Accepting requests for a working band is always a dangerous venture, if the songs are not on your normal sets. In this case, to limit the prospect of being caught out, we have an advance list of about 15 numbers that we have never played which we will whip up tomorrow evening. They are all well-known songs (standards in other words) and I was told when I was younger that if you wanted to be a competent musician then you had to know all the standards and be able to wheel them out at any time. Like tomorrow night.
Here is one of the requests – the famous song – Perfidia – originally published in 1939 and made a hit for the first time in 1940 by the Cuban singer and bandleader Xavier Cugat, who was a great artist in his own right.
The song is about human weakness and infidelity. Cugat was married five times and his first band was called ‘The Gigolos’!
To you, my heart cries out Perfidia[and so it goes]
For I found you, the love my life
In somebody else’s arms
With a sad lament my dreams
Have faded like a broken melody
While the Gods of love look down and laugh
At what romantic fools, we mortals be
Given that we are a rocksteady/reggae/dub band, we will not be doing the original Latin style version of the song. Rather, we will play this version, which is from – Phyllis Dillon – sometimes referred to as the Queen of Reggae, but, strictly speaking, she was dominant as a rocksteady artist.
She was a major recording artist for Duke Reid on his Treasure Isle label. His first fame came from his sound system in the 1950s (Duke Reid – The Trojan King of Sounds), which was one of the most popular mobile music systems (outdoor discothèques) in Kingston, Jamaica.
The name Trojan King of Sounds came from his British-built Trojan truck, which carted his sound system around the streets.
As an aside, Duke Reid’s sound system, led to the development of Trojan Records in Britain in 1968, which became a major distributor of ska, rocksteady, reggae and dub, all of the most wonderful music in the world.
As another aside, the releases from Trojan Records were popular across all of the so-called use sub-cultures in Britain (mods, skinheads and suede heads), which is interesting in itself and I have been researching an issue for some time and may write a book about it one day when I get sick of economics. I have a lot of material dating back to the early 50s on the topic.
All that is relevant because Phyllis Dillon recorded this version of Perfidia in 1967 and it was later released on a Trojan Records compilation.
As an aside, Phyllis Dillon’s connection to economics is that she took time out from her recording career to build a career as a banker, but we won’t hold that against her.
Here is a great interview with Phyllis Dillon from April 23, 1998.
Anyway, you can just rock back and forward, gently, all day listening to this stuff – rocksteady, beautiful.
Anyway, I have about 15 songs that I haven’t played for years to remember again for tomorrow night! The fun of it all.
The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.