Are central banks
throwing a progressive party?
You know, the kind of
party where folks travel from house to house feasting and drinking and enjoying
the proffered hospitality. For years pundits have speculated about what will
happen to the U.S. stock market party when the spiked punch bowl of
quantitative easing is gone. Last week, they got an unexpected answer: Come on
over to Japan’s house.
On Wednesday, the U.S.
Federal Reserve announced October marked the end of its third round of
quantitative easing (QE). Since late 2008, the Fed has purchased trillions of
dollars of government and mortgage-backed bonds in an effort to spur economic
growth (by increasing liquidity and lending) and head off deflation. In
October, The New York Times reported,
“The good news is that economy has been growing remarkably steadily since the
middle of 2009… Still, the pace of growth has been perpetually disappointing
for anyone expecting or betting on a return to the pre-crisis trend.”
Not long after the Fed
announced QE closing time, Japan’s central bank, Bank of Japan (BOJ), startled
stock markets with a Godzilla-sized surprise – it was expanding an already
significant quantitative easing program. As if that weren’t enough, the
President of Japan’s Government Pension Investment Fund (the world’s largest
pension fund) said the fund’s assets were being reallocated. Instead of having
60 percent invested in bonds, it would keep 35 percent in bonds and move the
balance to stocks. The news electrified stock markets. Barron’s reported:
“Stocks soared around
the globe while the yen plunged against the dollar and the euro. Extending the
previous week’s surge, the major U.S. equity gauges ended at records on Friday,
while stocks in Tokyo jumped more than 7 percent on the week to the highest
level since November 2007. Not to be left out, European stocks gained 3 percent,
their best weekly showing since last December.”
Barron’s also pointed out the real effect of a falling
yen was to export deflation to Japan’s trade partners. The drop in the value of
the yen on Friday translated into a $1,500 price cut on a $60,000 Lexus or
Acura, increasing competition for luxury German automobiles.
So, what’s the next
stop for revelers at the central bank fête? The
New York Times speculates it may be the Eurozone.
Why are people worrying about deflation? Deflation is a general
decline in prices. For anyone who has been struggling to make ends meet that may
not sound all bad. In fact, it’s not always bad. According to the Federal Reserve Bank of St. Louis, between
1876 and 1879, prices in the United States fell by about 5 percent per year, on
average, while the economy grew at a 7.6 percent clip.
Of
course, deflation is not always good either. Financial crises in the United States
during 1890, 1893, 1907, and the early 1930s were followed by periods of lower
economic growth and deflation. The
Economist described the harmful effects of deflation like this:
“It is a pernicious threat, all the more so
because, at its onset, it seems almost benign… The belief that money made
tomorrow will be worth less than money today stymies investment; the belief
that goods bought tomorrow will be cheaper than goods bought today chokes
consumption… Wages, incomes, and tax revenue all stall, undermining the ability
of households, businesses, and governments to pay their debts – debts which, in
real terms, will grow more burdensome under deflation.”
Deflation
is a greater threat in Europe than in the United States. The European Central Bank’s most recent
bulletin distinguished between deflation (a significant and persistent decline
in prices that becomes entrenched in expectations) and disinflation (a process
of decelerating inflation that may lead to negative inflation rates but is a
temporary state of affairs). Italy, Spain, Greece, Sweden, and Israel experienced
negative inflation in September, according to The Economist. It reported, “The IMF [International Monetary Fund] recently
put the odds of deflation in the euro zone – defined as two quarters of falling
prices in a 12-month span – at 30 percent in the coming year.”
Weekly Focus – Think About It
“And
so it began: a growing realization that the vampire genre is positively swollen
with economic questions. And the zombie genre? Maybe more so. Economic issues
take center stage in many undead narratives – and when they don’t, they’re
still lurking in the shadows.”
--Economics
of the Undead, A collection of essays
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