Politicians have been placing unrealistic expectations on the capacity for monetary policy to lift their economies out of recession. As a result, central banks have been under pressure to broaden their mandates to make it easier for them to boost economic growth. Yet the measures taken so far amount to nothing more than an unspoken policy of currency manipulation.
Recovery from a major financial crisis tends to be weaker and takes longer than recovery from a typical business recession/global downturn. Even though the IMF has come out against excessive fiscal consolidation, politicians have shied away from the traditional Keynesian remedy – largescale investment projects to replace ‘missing’ demand – because of the already heavy debt burdens. This has placed the entire onus somewhat unrealistically on monetary policy.
When dealing with inflation, central bankers play comfortably on home territory but with deflation they are on away ground. Their success has been variable. In the US, equity prices have been well supported, but the wider economy less so. In the UK, the largest quantitative easing programme ever seen failed to prevent a double-dip recession. In Japan, the central bank avoided full-blooded QE, barely expanded its balance sheet and kept real interest rates positive with an all-too-predictable result.
Serious changes are afoot in how central banks conduct monetary policy in the face of sluggish growth. The US Federal Reserve now places much greater weight on employment than inflation; the incoming governor of the Bank of England, a former co-head of sovereign risk at Goldman Sachs, has mooted a nominal GDP target, while Japan has imposed a higher inflation target on its central bank. In all these examples, currency manipulation is the policy that dare not speak its name.
A closer look at Japan is instructive. Until recently the yen had been strong for many years. This had caused a hollowing out of Japan’s domestic industry and a loss of global competitiveness. The yen was strong because Japan ran a trade surplus, the Bank of Japan maintained positive real interest rates against a background of modest deflation, the yen was regarded as a safe haven as Japan stuck to G20 pledges in late 2008 to avoid competitive devaluations and the market believed the West would not permit Japan to pursue a weak yen policy.
So what has changed? In Japan, the trade balance moved into deficit for the first time in 30 years. This indication of fragility led us to be short of the yen. Japan has been experiencing deflation for 20 years. It is natural for a country running a trade deficit to devalue its currency and trading partners such as the US have little justification for opposing such a move.
The yen’s first big fall came in early 2012 after the Bank of Japan adopted an inflation target of 1 per cent when the current inflation rate was -0.1 per cent. The second fall came with the victory of Shinzo Abe’s LDP in December 2012. Abe is determined to push the BoJ for more stimulus. He has doubled the inflation target to 2 per cent and has appointed Haruhiko Kuroda, a critic of recent central bank policy, as the new BoJ governor. The appointment could be as significant as that of Paul Volcker to the Federal Reserve in 1979, which reversed a decade of stagflation.
Miles Geldard is head of Jupiter fixed interest and multi-asset team