William De Vijlder

Group Chief Economist BNP Paribas

Fiscal and monetary policy

William De Vijlder examines fiscal and monetary policy through the lens of government and central bank decisions (including the ECB, the Federal Reserve and the Bank of England), with a special focus on changes in a country’s budget balance and public sector debt.

Balancier

Constraints on monetary policy push towards unconstrained investing

February’s surge in volatility, the recent dip in the eurozone’s growth momentum, the prospects of a series of US key rate hikes and of the ECB’s change of tone as it prepares to halt quantitative easing (QE) are all factors that risk intensifying arguments in favour of high conviction approaches to asset management in the months ahead: unconstrained investing makes a comeback.

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choices and decisions

US: FOMC (a)symmetries

The FOMC has an asymmetrical loss function: avoiding a recession is more important than avoiding the risk of overheating. With this comes the necessity of a symmetrical inflation objective: a temporary overshooting is acceptable. Given the unclear relationship between unemployment and inflation, the Fed’s tone remains cautious despite upbeat growth projections.

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ECB by night

ECB: predictable projections create dovish bias

Core inflation projections by the ECB have followed a surprisingly predictable path. Starting at close to but below 2% for long horizons, they decline as the remaining horizon shortens. The big difference between the projections at long horizons and the eventual outcome implies they provide little information to the market: they simple confirm the ECB’s objective. They can also introduce a dovish policy bias.

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US: playing with privilege

Fiscal reflation in a full employment economy makes it very likely that the US current account deficit will increase alongside the budget deficit. Despite rising bond yields, fuelled by the prospect of increasing budget deficits and monetary tightening, the dollar has weakened.

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US: inflation unease

After the upside surprise to hourly wages earlier this month, the consumer and producer price inflation numbers have also come in higher than expected. Anticipating inflation dynamics has become very difficult, as the Phillips curve has become less apparent. This forces investors and policy makers to pay more attention to recent data than to long-term relationships.

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US rates and emerging markets – no spillover yet

Historically, a rising rate environment in the US has been a matter of concern for developing economies. It seems that this time is different: despite rising US yields, emerging market currencies have strengthened. This has contributed to a weakening of the effective exchange rate of the dollar and an easing of financial conditions in the US.

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EcoTV Week – 02/02/2018: Three perspectives on US economic policy

The combination of tax cuts and a still accommodative monetary policy should be very supportive for growth in the short run, all the more so given the easing of financial conditions (rise in equity market, weakening of the dollar). The longer run perspective is more sobering: limited potential to cut policy rates and a reduction of the fiscal policy space. Addressing growth slowdowns will be more challenging than ever.

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ECB forward guidance: well-intended vagueness

The ECB is upbeat on the growth outlook but considers that inflation remains subdued. Nevertheless, it still expects inflation to rise to 1.7% in 2020. The refusal to label this as being sufficiently close to its objective reflects a cautious attitude as well as an effort of being vague for a good reason.

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