Sometimes a cluster of major events happens all at once in just a few days. We had the significant Bank of Japan announcement, a bad payrolls number in the US, nuclear theatrics in North Korea, nerves about Portugal, and Obama is about to release his budget. I didn’t have time to fully update things on the blog, but it’s been a very interesting weekend.
But this has to be said: we really are near the point where normal monetary and fiscal policy is exhausted. This is the end game.
It is good news that the Japanese are taking such decisive action. It is bad news that it is necessary. They have tried fiscal expansion on a scale that few others have ever dared, and it has not worked. Now they are trying to do a Dr Frankenstein on their economy with an unprecedented monetary jolt. It is a brave act, but also smells of desperation. Normal medicine has not worked so the surgeon is jumping up and down with electrodes and clamps and a mad-scientist air. If the economy gets off the operating table, it may be hard to like the ugly outcome.
The direct quantitative impact of monetary (and fiscal) measures is almost beside the point, for all the person-years that have been spent on constructing models to quantify the impact of QE, or debating multipliers in fiscal policy, or pondering blockages in the transmission mechanism.
Sure, we can talk about whether the BoJ can keep control of inflation, whether 10-year JGBs continue to gap and trade in a disorderly way, or whether we are on the way to disguised currency war. This is going to be a major subterranean crack in bond markets.
However, the real objective of policy here is to reset expectations so the economy can generate its own momentum. As I’ve said before, economics does have a very good empirical understanding of expectations formation. The fundamental question now is whether the average person on the street comes to believe things are going to get better. That will be the real thing to watch in Japan, not inflation or JGBs (unless you hold the bonds).
That’s why the labor number in the US is also important. One bad number could be a blip. The next one will matter, however, because consumer confidence is fragile.
I still think US recovery is on track, because modern economies have a natural tendency to adjust and recover despite policy mistakes. It’s the base rate.
Central bankers (and government spending) can at best buy time for natural healing to take place. The Fed and BoJ and others are doing their best (despite criticism from the likes of David Stockman) but at some point the patient has to get up off the operating table and walk for himself, without the drip feed of QE. The central banks can’t themselves cure the sickness.
What happens if the latest policy jolts do not work? The economy will still cure itself, but through something more like a burning fever of brutal adjustment than a slow recovery.