Monetary tightening will not solve Mozambique’s problems

I have an op-ed over at Zitamar News.

Opinion: Tighter monetary policy can’t change the fact that Mozambique has become poorer

Mozambique is facing the same situation as many other low-income commodity-exporting countries – the price of its main exports have declined sharply in the past two years. In the case of Mozambique, aluminium in particular.

By definition that means that the country is poorer than it was two years ago. Mozambique has also become poorer due to the suspension of some foreign aid programs and higher food prices due to drought.

There is no way around it and the central bank – Banco De Moçambique – can do little about it as these are all negative supply shocks. However, it is nonetheless facing a dilemma.

As terms-of-trade worsen (export prices drop relative to import prices), Mozambique has two options: either it can accept that this will cause the value of the metical to fall, which in turn pushes inflation up and thereby reduces real incomes to reflect that Mozambique has become poorer – or it can fight the drop in the metical by tightening monetary conditions. This is what it did yesterday when it hiked its key policy rate by 300bp to 17.25%, and tightened reserve requirements.

Read the rest here.


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The Euro – Monetary Strangulation continues (one year on)

Exactly one year ago today I was with the family in the Christensen vacation home in Skåne (Southern Sweden) and posted a blog post titled The Euro – A Monetary Strangulation Mechanism. I wrote that post partly out of frustration that the crisis in the euro once again had re-escalated as Greece fell deeply into political crisis.

One year on the euro zone is once again in crisis – this time the focal point it the Italian banking sector.

So it seems like little has changed over the past year. After nearly eight years of crisis the euro zone has still not really recovered.

In my post a year ago I showed a graph with the growth of real GDP from 2007 to 2015 in 31 different European countries – both countries with floating exchange rates and countries within the euro areas and countries pegged to the euro (Bulgaria and Denmark).

I have updated the graph to include 2016 (IMF forecast).

Monetary Strangulation Summer 2016.jpg

The picture is little changed. In general the floaters (the ‘green’ countries) have done significantly better than the peggers/euro countries (the ‘red’ countries).

That said, I am happy to admit that it looks like we have had some pick-up in growth in the euro zone in the past year – ECB’s quantitative easing has had some positive effect on growth.

However, the ECB is still not doing enough as new headwinds are facing the European economy. Here I particularly want to highlight the fact that the Federal Reserve – wrongly in my view – has moved to tighten monetary conditions over the past year, which in turn is causing a tightening of global monetary conditions.

Second, if we look at the money-multiplier in the euro zone it is clear that it over the past nearly two years have been declining somewhat due in my view to the draconian liquidity (LCR) and capital rules in Basel III, which the EU has pushed to implement fast.

Furthermore, given the increase in banking sector distress in the euro zone recently the euro zone money-multiplier is likely to drop further, which effective will constitute a tightening of monetary conditions. If the ECB does not offset these shocks the euro zone could fall even deeper into a deflationary crisis.  If you are interested in what I think should be done about it have a look here and here.

Concluding, the monetary strangulation in the euro zone continues. Luckily, again this year at this time it is vacation time for the Christensen family so I will try to enjoy life after all.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

The Italian bank crisis – the one graph version

Today I was interviewed by a Danish journalist about the Italian banking crisis (read the interview here). He asked me a very good question that I think is highly relevant for understanding not only the Italian banking crisis, but the Great Recession in general.

The question was: “Lars, why is there an Italian banking crisis – after all they did NOT have a property markets bubble?”

That – my regular readers will realise – made me very happy because I could answer that the crisis had little to do with what happened before 2008 and rather was about monetary policy failure and in the case of the euro zone also why it is not an optimal currency area.

Said, in another way I repeated my view that the Italian banking crisis essentially is a consequence of too weak nominal GDP growth in Italy. As a consequence of Italy’s structural problems the country should have a significantly weaker “lira”, but given the fact that Italy is in the euro area the country instead gets far too tight monetary conditions and consequently since 2008 nominal GDP has fallen massively below the pre-crisis trend.

That is the cause of the sharp rise in non-performing loans and bad debt since 2008. The graph below clearly illustrates that.

Bad debt NGDP Italy.jpg

I think it is pretty clear that had nominal GDP growth not fallen this sharply since 2008 then we wouldn’t be talking about an Italian banking crisis today. There was no Italian “bubble” prior to 2008 and there are no signs that Italian banks have been particularly irresponsible, but even the most conservative banks will get into trouble when nominal GDP drops 25% below the pre-crisis trend.

Therefore, I also don’t think that the “solution” to the crisis is a re-capitalisation of the Italian banks or of the entire European banking sector. Rather the solution is to ensure nominal stability in the euro zone. The best way of doing that would be for the ECB to aggressive increase the money base to ensure 4% NGDP growth in the euro zone (see my recent post on what the ECB in the present situation here and my post from 2012 on a cheap firewall against an escalation of the crisis here.)

A key problem, however, is that the euro zone is not an optimal currency area. In a good recent blog post my friend Marus Nunes rightly argued that there is a “Northern” part of the euro zone where monetary policy broadly speaking is “right” and a “Southern” part, where monetary policy is far too tight. Italy is part of this later group.

This means that the question is whether keeping euro zone nominal demand “on track” is enough to ensure enough NGDP growth in the Southern countries to avoid banking and sovereign debt crisis coming back again and again. Unfortunately the development over the past eight years gives little reason for optimism.

PS There are now also increasing talk about problems in the German banking sector. Given the fact that the German economy has doing quite well compared to most other economies in Europe this is rather incredible. Therefore if we should talk about imprudent banking (due to moral hazard problems) then we might want to point the fingers at the German banks.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

A gameplan for the ECB – it is not complicated

A very good friend of mine asked me what the ECB should do in the present situation where inflation and inflation expectations continues to run well-below the ECB’s inflation target.

Here is my answer – it is what we could call a gameplan for the ECB (it could easily be used by other central banks as well):

1) Stop communicating in the terms of interest rates. Announce a PERMANENT growth rate for the money base. Announce that the growth rate will be stepped up every month or quarter until inflation expectations are at 2% at all relevant time horizons – for example 2y2y swap inflation expectations. At every ECB meeting the permanent money base rate is announced.

2) Control the money base by buying a basket of global AAA-rated govies.

3) Announce a NGDP LEVEL target consistent with the 2% inflation target and announce that the ECB will not let bygones be bygones – meaning if you undershoot the target one year then you should overshoot the following year.

4) Internal forecasting should be given up. Instead only surveys of professional forecasters and market forecasts should be used for policy input. In the reasoning for the money base growth target there should be given only a reference to these forecasts and the ECB should commit itself to set money base targets based on these forecasts and nothing else.

And what could the of EU do?

1) Suspend the implementation of Basell III and other banking regulation that depress the money multiplier and increase demand for safe assets until nominal GDP has grown for at least 4% for 8 quarters in a row.

And maybe also…

2) Suspend the growth and stability pact for now.

I think it is very easy to create inflation and nominal demand. It is all about commitment. Unfortunately the ECB does not have such commitment.

PS this is essentially what I earlier have called a forward-looking McCallum rule – see also a similar suggestion for the Fed here.

Lack of NGDP growth is the real reason for Italy’s banking crisis

Back in April I wrote this:

I hate to say it, but I fear that we are in for a new round of euro zone troubles.

My key concern is that monetary conditions in the euro zone remains far to tight, which among other things is reflected in the continued very low level of inflation expectations in the euro zone. Hence, it is clear that the markets do not expect the ECB to deliver 2% inflation any time soon. As a consequence, nominal GDP growth also remains very weak across the euro zone.

…And Spain is not the only euro zone country with renewed budget concerns. Hence, on Friday Italy’s government cut it growth forecast for 2017 and increased it deficit forecast. Portugal is facing a similar problem – and things surely do not look well in Greece either.

So soon public finances problem with be back on the agenda for the European markets, but it is important to realize that this to a very large extent is a result of overly tighten monetary conditions. As I have said over and over again – Europe’s “debt” crisis is really a nominal GDP crisis. With no nominal GDP growth there is no public revenue growth and public debt ratios will continue to increase.

…So be careful out there – soon with my might be in for euro troubles again.

I think we have moved closer to this “euro spasm” and it is now particularly showing up in the form of worries over the state of the Italian banking sector, which adds to the concerns that the markets already have about the state of Italian public finances.

So while the global financial markets seem to been recovering from the initial shock from the outcome of the United Kingdom’s EU referendum and even though the EU system clearly still is in shock from the ‘Brexit’ decision it is clear that the global financial markets seem to have stabilised after a short-lived spasm.

However, for the EU it is far too early to conclude that we are out of the woods. In fact, Brexit might not be the biggest worry for the EU. Instead the next big worry might be Italy.

Italy – 15 years without growth

Italy is without a doubt one of Europe’s absolute worst performing economies over the past decade and recently fears over the state of the Italian banking sector has yet again resurfaced and in the direct aftermath of the Brexit crisis Italian Prime Minister Matteo Renzi has suggested a major bailout package for the Italian banking sector.

However, such plans would likely be in conflict with EU’s new rules that basically means such bailouts should be financed primarily by depositors and creditors rather than by taxpayers so for now it looks like Renzi cannot get an ok from the EU for a new banking rescue package. That, however, doesn’t change the fact that the Italian banking sector is in serious trouble and Italian bank shares have been more than halved in value this year.

The Italian banking sectors’ trouble has little to do with the Brexit vote. Rather the main reason the Italian banking sector is under water is the same reason why Italian public finances are a mess – lack of economic growth.

Hence, there essentially hasn’t been any recovery in the Italian economy since 2008. In fact, real GDP is today nearly 10% lower than it was at the start of 2008 and even worse – real GDP today is at the same level as 15 years ago! 15 years of no growth – that is the reality of the Italy economy.

And have a look at the nominal GDP growth in Italy:

Skærmbillede 2016-07-07 kl. 14.04.10

In the decade prior to 2008 Italian NGDP grew more or less at a straight line. However, since 2008 actual nominal GDP level has fallen massively short the pre-crisis trend.

There are numerous reasons for Italy’s lack of (both real and nominal) growth. One thing is the fact that Italy is in a currency union – the euro area – in which it should never had become a member. Italy’s deep crisis warrants massive monetary easing – in other words Italy needs a much weaker ‘lira’, but Italy no longer has the lira and as a consequence monetary conditions remains too tight for Italy.

Furthermore, Italy is marred by serious structural problems – for example rigid labour market regulation and negative demographics. As a consequence, the growth outlook remains quite bleak.

And even though growth has picked up slightly over the past year it is hardly impressive and latest round of market turmoil has likely further dented Italian growth and Italy could easily fall into recession again in the coming quarters if the banking trouble escalates.

With no growth is it hard to see both private and public debt levels coming down in any substantial way and as a consequence we are very likely to soon again see renewed worries about both the Italian banking sector and Italian public finances. As consequence the EU’s next headache might very well be Italy.



It is time for BoE to make the 4% NGDP target official

While I do not want to overestimate the effects of Brexit on the UK economy it is clear that last week’s Brexit vote has significantly increased “regime uncertainty” in the UK.

As I earlier have suggested such a spike in regime uncertainty is essentially a negative supply shock, which could turn into a negative demand shock if interest rates are close the the Zero Lower Bound and the central bank is reluctant to undertake quantitative easing.

In the near-term it seems like the biggest risk is not the increase in regime uncertainty itself, but rather the second order effect in the form of a monetary shock (increased money demand and a drop in the natural interest rate below the ZLB).

Furthermore, from a monetary policy perspective there is nothing the central bank – in the case of the UK the Bank of England – can do about a negative supply other than making sure that the nominal interest rate is equal to the natural interest rate.

Therefore, the monetary response to the ‘Brexit shock’ should basically be to ensure that there is not an additional shock from tightening monetary conditions.

So far the signals from the markets have been encouraging 

One of the reasons that I am not overly worried about near to medium-term effects on the UK economy is the signal we are getting from the financial markets – the UK stock markets (denominated in local currency) has fully recovered from the initial shock, market inflation expectations have actually increased and there are no signs of distress in the UK money markets.

That strongly indicates that the initial demand shock is likely to have been more than offset already by an expectation of monetary easing from the Bank of England. Something that BoE governor Mark Carney yesterday confirmed would be the case.

These expectations obviously are reflected in the fact that the pound has dropped sharply and the market now is price in deeper interest rate cuts than before the ‘Brexit shock’.

Looking at the sharp drop in the pound and the increase in the inflation expectations tells us that there has in fact been a negative supply shock. The opposite would have been the case if the shock primarily had been a negative monetary shock (tightening of monetary conditions) – then the pound should have strengthened and inflation should have dropped.

Well done Carney, but lets make it official – BoE should target 4% NGDP growth

So while there might be uncertainty about how big the negative supply shock will be, the market action over the past week strongly indicates that Bank of England is fairly credible and that the markets broadly speaking expect the BoE to ensuring nominal stability.

Hence, so far the Bank of England has done a good job – or rather because BoE was credible before the Brexit shock hit the nominal effects have been rather limited.

But it is not given that BoE automatically will maintain its credibility going forward and I therefore would suggest that the BoE should strengthen its credibility by introducing a 4% Nominal GDP level target (NGDPLT). It would of course be best if the UK government changed BoE’s mandate, but alternatively the BoE could just announce that such target also would ensure the 2% inflation target over the medium term.

In fact there would really not be anything revolutionary about a 4% NGDP level target given what the BoE already has been doing for sometime.

Just take a look at the graph below.


I have earlier suggested that the Federal Reserve de facto since mid-2009 has followed a 4% NGDP level target (even though Yellen seems to have messed that up somewhat).

It seems like the BoE has followed exactly the same rule.  In fact from early 2010 it looks like the BoE – knowingly or unknowingly – has kept NGDP on a rather narrow 4% growth path. This is of course the kind of policy rule Market Monetarists like Scott Sumner, David Beckworth, Marcus Nunes and myself would have suggested.

In fact back in 2011 Scott authored a report – The Case for NGDP Targeting – for the Adam Smith Institute that recommend that the Bank of England should introduce a NGDP level target. Judging from the actual development in UK NGDP the BoE effectively already at that time had started targeting NGDP.

At that time there was also some debate that the UK government should change BoE’s mandate. That unfortunately never happened, but before he was appointed BoE governor expressed some sympathy for the idea.

This is what Mark Carney said in 2012 while he was still Bank of Canada governor:

“.. adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.

when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand.

Shortly after making these remarks Mark Carney became Bank of England governor.

So once again – why not just do it? 1) The BoE has already effectively had a 4% NGDP level target since 2010, 2) Mark Carney already has expressed sympathy for the idea, 3) Interest rates are already close to the Zero Lower Bound in the UK.

Finally, a 4% NGDP target would be the best ‘insurance policy’ against an adverse supply shock causing a new negative demand shock – something particularly important given the heightened regime uncertainty on the back of the Brexit vote.

No matter the outcome of the referendum the BoE should ease monetary conditions 

If we use the 4% NGDP “target” as a benchmark for what the BoE should do in the present situation then it is clear that monetary easing is warranted and that would also have been the case even if the outcome for the referendum had been “Remain”.

Hence, particularly over the past year actual NGDP have fallen somewhat short of the 4% target path indicating that monetary conditions have become too tight.

I see two main reasons for this.

First of all, the BoE has failed to offset the deflationary/contractionary impact from the tightening of monetary conditions in the US on the back of the Federal Reserve becoming increasingly hawkish. This is by the way also what have led the pound to become somewhat overvalued (which also helps add some flavour the why the pound has dropped so much over the past week).

Second, the BoE seems to have postponed taking any significant monetary action ahead of the EU referendum and as a consequence the BoE has fallen behind the curve.

As a consequence it is clear that the BoE needs to cut its key policy to zero and likely also would need to re-start quantitative easing. However, the need for QE would be reduced significantly if a NGDP level target was introduced now.

Furthermore, it should be noted that given the sharp drop in the value of the pound over the past week we are likely to see some pickup in headline inflation over the next couple of month and even though the BoE should not react to this – even under the present flexible inflation target – it could nonetheless create some confusion regarding the outlook for monetary easing. Such confusion and potential mis-communication would be less likely under a NGDP level targeting regime.

Just do it Carney!

There is massive uncertainty about how UK-EU negotiations will turn out and the two major political parties in the UK have seen a total leadership collapse so there is enough to worry about in regard to economic policy in the UK so at least monetary policy should be the force that provides certainty and stability.

A 4% NGDP level target would ensure such stability so I dare you Mark Carney – just do it. The new Chancellor of the Exchequer can always put it into law later. After all it is just making what the Bank of England has been doing since 2010 official!

Brexit is not a major global shock

It rarely happens, but sometimes Scott Sumner and I disagree and that is the case presently.

Scott sees Brexit as a major negative global shock, while I think that Brexit on its own is not really a big deal.

The paradox is that going into the latest political and market events Scott has actually been rather relaxed about both the global economy and the US economy, while I have been a lot more worried.

I have been worried that premature monetary tightening could send the US economy into recession and could blow the ‘dollar block’ up and in the process cause a major Chinese crisis and at the same time I have in the latest couple of months also started to worry that slowing nominal GDP growth in the euro zone could cause another ‘euro spasm’.

I very much worry about these issues and therefore I am hardly think that the Brexit vote is doing much to help things and I personally am deeply worried and frustrated that this might to a very large extent be yet another example of increased nationalism and anti-immigrant populism across Europe, the UK and the US.

But Brexit in my view is just yet another factor that could further deepen the crisis – and I have discussed the mechanics of it in my previous post – but on its own I don’t think this is a major negative shock to the global economy. It can develop into a very bad shock if monetary policy once again fails, but from what we have seen so far in the financial markets the shock is not particularly big.

Yes, it is correct that we saw some rather dramatic market action on Friday and Monday, but if we look at the market action over the past week or over the past month there is nothing particularly alarming about it.

Let me try to illustrate it by looking at a couple of markets. Lets start out with the dollar. This is weekly changes in EUR/USD since the beginning of 2015.


The Brexit ‘shock’ is the very last down move in EUR/USD (a stronger dollar). This is consistent with what we would normally seen when we have a spike in risk aversion in the markets – the dollar as the main reserve currency of the world strengthens.

Hence, we see the dollar has strengthened over the past week, but it is barely more than one standard deviation (from 2008 until today) and there has been numerous weekly moves in the dollar just since 2015 that have been significantly larger particularly during 2015.

The story is more or less the same if we look at the global stock markets. This is weekly changes in the MSCI World Index of global stocks.

 MSCI World Brexit.jpg

Here the drop is slightly bigger than one standard deviation, but the drop in global stocks is not bigger than what we saw during a couple of weeks in January and February and significantly smaller than what we saw last year.

This is of course only two examples, but there are other s- for example the implied volatility in the US stock market (VIX) or the change in inflation expectations (they are down in the US and the euro zone, but not a lot and actually up in the UK and Japan).

Of course Brexit matters, but there are a lot more important things that should worry us more

My point is not that Brexit does not matter. It certainly does in all kinds of ways and it could end up being a horrible thing, but it might also – in a dream scenario – end up being a positive thing (the EU establishment will understand the message and reform and UK might not turn crazy anti-immigrant).

The markets are assessing these risks and judging from that the global financial markets are telling us that Brexit in itself is not a major negative event for the global economy and even though I am sad to see the UK (potentially) leave the EU I would agree with the market – Brexit is not the end of the world.

That, however, does not mean that I am particularly optimistic about the global economy at the moment. Hence, I continue to think that the Fed has been way too aggressive in terms of rate hikes and I fear that the Fed does still not understand that there is a significant risk of an US recession in the near future (even disregarding any effects from Brexit) and similarly and I am deeply concerned that we soon could have another “euro spasm” as a consequence of slowing nominal GDP growth and finally it is far too early to say that things are all well in China.

On a positive note Brexit might be the “excuse” both the ECB and the Federal Reserve need to reverse course and in the case of Fed cut rates rather than hiking.

In fact this is what the markets already are pricing in. And that should be remembered – because that is now the benchmark by which we should judge the Fed. Hence, if Yellen does not soon spell out that rates are more likely to be cut than being hiked then the risk of more market turmoil clearly increases.

Hence, maybe the real story is not whether Boris Johnson will become British Prime Minister or whether Jean-Claude Juncker learns to behave himself, but rather the question is whether the ECB and the Fed finally will get their act together and ensure a re-anchoring of inflation expectations. I am not too optimistic on that part.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:




Brexit: Regime Uncertainty at the Zero Lower Bound

Brexit is on everybody’s mind and even before the – for the markets – surprising “Leave” vote on Thursday the British EU referendum was the dominating theme in the markets for awhile. When the news came out early Friday morning, the global financial markets reacted strongly.

That is the kind of reaction we are used to when we have a major “risk off” shock – stock markets drop sharply, the yield curve flattens, market inflation expectations drop, the pound weakens significantly and the dollar strengthens.

However, the question is what kind of shock it really is. The answer is that the Brexit shock initially is a supply shock that turns into a demand shock. I will try to explain that in this post.

Increased “regime uncertainty” is initially a supply shock

 The fact that the Brits voted to leave the EU in my view best can be described as what Robert Higgs called “regime uncertainty”. A shock that increases regime uncertainty is essentially a shock that increases uncertainty about the overall institutional framework in the economy – in this case: Will the UK be a member of the EU’s single market in the future? What will Brexit mean to the free movement of labour in Europe? Will UK banks be able to operate freely as before in other EU countries etc.?

This is the regime uncertainty regarding the UK economy, but equally, we have increased regime uncertainty within the EU. Will this for example lead to other countries leaving? Will this cause the “new” to drift in a more interventionist direction? Will this make it harder to get reforms through?

Essentially such regime uncertainty is a negative supply shock that should cause real GDP (growth) to drop in both the EU and the UK and cause an increase in inflation.

This in itself is bad enough but the historical experience shows that such shocks rarely have major impact and are of a relatively short-lived character and most observers of the situation likely would also agree that the EU and the UK will have a common interest in finding a solution that overall keeps the UK as part of the EU’s single market and realistically then it would not be unreasonable to assume that the overall level of tariffs and trade barriers in the UK and the EU will not be much changed in 5-10 years time.

So yes, Brexit has increased regime uncertainty, but on its own it shouldn’t be a matter that significantly should change the medium-term outlook for the EU and the UK economies.

The monetary shock is the most important shock

So while we have seen an increase in regime uncertainty, I believe a more important factor is what is happening to monetary conditions as a second order effect of the increase in regime uncertainty.

First of all, it is clear that Brexit has caused an increase in particular demand for US dollar and other safe assets. This is essentially a precautionary increase in money demand and for a given money base this a passive tightening of monetary conditions.

Secondly in my view, more importantly, the increase in regime uncertainty should basically be seen as a drop in the expected trend growth rate in both the UK and the euro zone. This means that we should expect the natural interest rate to drop both in the UK and in the euro zone and maybe even globally.

Given that both the Bank of England, the ECB and the Federal Reserve are targeting interest rates (using them as a policy instrument rather than using the money base) and that all three central banks have interest rates close to the Zero Lower Bound (ZLB) a drop in the natural interest rate (caused by a negative supply shock) will cause an increase in the difference between the policy rate(s) and the natural interest rate(s), which effectively is a tightening of monetary conditions.

This would not be a problem if interest rates where significantly above the ZLB as markets then just would expect central banks to cut rates. Similarly, it wouldn’t be a problem – even at the ZLB – if central banks were using the money base as a policy instrument as that would mean the central bank always would be able to ease monetary policy.

Unfortunately, both the ECB and the Federal Reserve do not seem overly eager to re-start/step up quantitative easing. As such, they have mentally committed themselves to a “liquidity trap”, which means that negative supply shocks automatically also turn into negative demand shocks.

It wouldn’t have to be this way and the Bank of England, which the markets clear perceive to be more willing to step up quantitative easing if necessary, in fact provides a good example of this. Hence, while inflation expectations have dropped both in the euro zone and the US, the opposite is the case in the UK where inflation expectations actually has to increase – and has been more or less flat over the past month. This clearly indicates that the markets expect the BoE to try to offset the negative shock from Brexit by easing monetary conditions. This by the way also give some reason to be optimistic about the macroeconomic impact of Brexit even in the near term.


In this regard, it is also notable that we have seen a sharper increase in the Credit Default Swap (CDS) on Italy than on the UK CDS on the back of Brexit. Said in another way, Brexit is hitting the euro zone harder than the UK.

Why is that? To me, the difference is that the UK has a floating exchange rate and a central bank willing to offset negative shocks, while Italy or other euro zone countries do not have an independent monetary policy to offset the shock from Brexit and the ECB likely also is less willing to ease monetary policy than the Bank of England is.

So once again – blame the ECB

 Yes, I know – it is Lars’ Law: Always blame the ECB. But I can’t help myself. It is clear to me that had the ECB been committed to at least hitting its inflation target and the markets had seen this target as credible, supply shock in the form of increased regime uncertainty would have had a much smaller negative impact than presently seems to be the case.

It is the failure of not only the ECB, but also of the Federal Reserve to ensure nominal stability and well-anchored inflation expectations that is magnifying this crisis.

There are worse things than Brexit

 Finally, I would like to note that even though distress has increased in the global financial markets since Thursday, there is no reason to panic over this “event” on its own. Had we had credible inflation targeting or even better, nominal GDP targeting central banks in Europe and the US then this would not be a big deal even for the global economy.

In fact, even taking into account the lack of credibility of the Fed and the ECB the market reaction might not have been quite a big as some (like my friends Scott Sumner and David Beckworth) seem to believe. Hence, if we look at for example the global stock markets they are little changes over the past 1-2 weeks. The same goes for the dollar and the global commodity markets. And most importantly, even though the shock has caused inflation expectations to drop – the drop has not in anyway been major.

Therefore, I actually believe that the focus should not really be on Brexit in itself. Rather I think it is much more worrying that the Federal Reserve has been overly eager to hike interest rates and as a consequence US inflation expectations have continued to decline since 2014.

Obviously as I discussed above these issued are linked in the since that the continued de-anchoring of inflation expectations both in the US and the euro zone increase the risk that any shock will be significantly amplified by lack of monetary policy credibility.

Therefore, it is of utmost importance that both the Fed and the ECB ensure nominal stability. That would mean a much stronger commitment to anchoring inflation expectations at 2% and a clear announcement that both central banks will increase money base growth if necessary to ensure their nominal targets. Unfortunately we have yet to see such commitment.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:


Brexit: The Press Release the Fed should have put out

The Federal Reserve just released the following statement:

The Federal Reserve is carefully monitoring developments in global financial markets, in cooperation with other central banks, following the results of the U.K. referendum on membership in the European Union. The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.

That is all fine, but this is the statement the Fed really should have released instead:

“The members of the Federal Open Market Committee notes that the British people has voted to leave the European Union. The decision today has caused an increase in volatility in global financial markets and increased demand for safe assets including increased demand for the US dollar. This effectively is an unwarranted tightening of US monetary conditions.

While the Federal Reserve is not in the business of fine tuning neither the US economy nor the financial markets the Federal Open Market Committee nonetheless would like to remind market participants that the Federal Reserve has an 2% inflation. Expectations for Fed Fund rates should reflect this target and so should expectations for potential asset purchases.

Presently market inflation expectations on all relevant time horizons are below this target and the Federal Reserve therefore stand ready to take the appropriate action to ensure inflation expectations match the 2% inflation target. In this regard it should be noted that the Federal Reserve has the ability to increase the money base as much as necessary to hit this this target.

This means that the Federal Reserve remains committed to offsetting any internal and external shocks to nominal demand in the US economy that might jeopardize the inflation target. The Federal Open Market Committee will not allow inflation expectations to drift significantly away from the 2% inflation target.”

…Ideally it should of course say “4% Nominal GDP target” instead of “2% inflation target”, but for now lets just hope the Fed will take the 2% inflation target serious.

I will try to write more on Brexit in the coming days, which I essentially think is a “Remain Uncertainty”-shock (a supply shock) to the European economy that causes the “natural interest rates” to drop further below the the Zero Lower Bound. This in turns causes an tightening of monetary condition as the markets do not fully trust the ECB (and the Fed) to use to its ability to control the money base to offset this shock.

PS I think Scott Sumner is overestimating the scale of the “monetary shock” as a result of Brexit. Scott would realize this by looking at the change in the dollar, stock markets and inflation expectations over the past week instead of looking only at the market action today. The shocks related to a more hawkish Fed and toubles in China in August last year and in January-February this year were larger.

Beckworth talks to Hetzel

David Beckworth has a great interview with my friend and great hero Robert Hetzel. Listen here.


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