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Central banks will move goal posts to keep QE forever

  • By Matthew Lynn,
  • MarketWatch
  • – 12/11/2013
  • Economic Insight
  • Market Analysis
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LONDON — Forget the reforms in China, whether the euro survives, or whether Apple (AAPL) ever gets around to launching that incredibly expensive watch that sends e-mails, plays games, and possibly even tells you what time it is.

Right now, there is only one thing that really matters to the markets. And that is whether central banks will continue with quantitative easing and stick with interest rates at three-century lows — and if not, when they will stop printing money and get rates back to something close to normal levels.

In the U.K., rates were meant to start going up when the unemployment rate dropped to 7%. In the U.S., the Federal Reserve targeted a 6.5% jobless rate. But now the Bank of England is looking at rising real wages as a potential trigger for rates to get back to normal, while the Fed is discussing shifting its target from 6.5% unemployment to 6% or else when an inflation floor has been hit.

The reality is, they will keep moving the goal posts. Once you slash interest rates to zero, and start printing money, it is impossible to stop without doing huge damage to the economy. QE and zero rates are going to be around for a lot longer than most investors have yet realized. The only historical experience we have of this kind of extreme monetary policy is Japan — and it tells us it carries on for two decades and perhaps longer.

Take a look at what has happened in the U.K. When Mark Carney took over from Sir Mervyn King at the Bank of England, he bought with him his much-trumpeted policy of "forward guidance." Rates would stay at 0.5% at least until the unemployment rate came back down to 7%. Only then would the bank start to edge them back up to the 5% or so that you would expect for a normal economy.

Carney probably thought that moment was safely out in the far distant future. After all, the U.K. still seemed stuck in a deep recession. He might well be safely back in Canada by the time the target was actually met.

As it turns out, however, the U.K. economy has had a stronger bounce back than the bank or anyone else expected. In the third quarter alone, it expanded at 0.8%, the fastest rate among major industrial nations. Given that the U.K. is also good at creating lots of low-paying jobs (although unfortunately not the high-paying sort), unemployment has come down faster than forecast. The latest monthly figures showed unemployment dropping to 7.6% from 7.8%: at that pace, rates will be going up before next spring.

So what does the bank do? It has started making noises about how the 7% target is not set in stone. Instead, it will look at other factors, such as what is happening to real wages, or the rate of productivity growth, before tightening monetary policy.

Much the same thing is happening in the U.S.

Back in May, Fed Chairman Ben Bernanke suggested a 7% or 6.5% unemployment rate would be a good moment to start getting monetary policy back to normal. Now 7% is here, and there is still no sign of it.

Last month, two papers by a pair of Fed officials discussed whether 6.5% was not a little on the high side, and suggested a 6% target instead. Another paper this month has suggested an "inflation floor" could be the trigger instead: that would rule out any rate hikes until inflation was up to 2% or even 1.5%.

Just like the Bank of England, the central bank set out a pair of clear goal posts, then quickly moved them as soon as there was any chance of the target actually being reached.

Cynics will argue that is just muddled policy making. But, in fact, something more interesting is going on, even though many central bankers may not have admitted it to themselves yet. Once you slash interest rates to close on zero it is very hard to get them back up again. Likewise, once you turn on the printing presses, it is incredibly difficult to stop them.

History is the best guide, and its lesson could hardly be clearer. Japan cut its interest rates to 0.5% all the way back in September 1995. Nearly two decades later, they still haven't gone back up again. Nor will they any time soon — in fact, the Bank of Japan keeps on chucking more and more stimulus at the economy.

The U.S., the U.K., or indeed the euro zone, now that it has got its rates down to record lows as well, will not be any different. Why should they? There is very little sign of inflation taking off — in fact, in most of the world it is coming down. Asset bubbles might be popping up all over the place, but if central bankers worried about those they have not shown any sign of it yet. Meanwhile, near-zero rates have long since stopped being an "emergency measure" and have become the new normal.

They are embedded in the economy. The rate rises that would get them back to "normal" are simply too extreme. Companies have issued billions in bonds, mortgages have been taken out, and governments have run up vast deficits, on which they are paying 2% interest or less.

Is it really possible to triple all those payments without creating a wave of bankruptcies, repossessions and massive cuts in public spending? Of course not.

Central banks set a target for getting rates back to normal, then promptly shift it.

The main priority for central bankers such as Mark Carney and Janet Yellen over the next couple of years will be finding fresh excuses for shifting the target again. Rates will rise once husbands always remember their wedding anniversaries. QE will be "tapered" once children go to bed on time. Monetary policy will get back to normal when Tom Cruise makes a decent film again.

The trick will be to find something so unlikely, there is no chance of the target ever being met — because the reality is once rates have been at 0.5% for five years it is impossible to ever get them back to normal.

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