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.

Japon Mont Fuji

Japan: moving to yield curve slope control?

The Japanese government bond yield curve has been flattening in recent months, with very long maturities coming dangerously close to 0%. This is creating concerns amongst institutional investors with long-dated liabilities (insurance companies, pension funds). Bank of Japan Governor Kuroda has argued that an excessive decline in super-long-term interest rates could negatively impact economic activity
This has raised expectations that the central bank could shift to a policy of controlling the slope as well as the level of the yield curve. This could influence bond yields abroad. In the eurozone it would intensify the debate about the impact of ECB policy on pension funds and insurers.

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Berlin Government district

Germany: fiscal stimulus, hope versus reality

Germany is probably in a technical recession and recent data do not point to any improvement in the near term, quite to the contrary. Given the country’s considerable budget surplus, German business leaders are calling for fiscal stimulus. This echoes Mario Draghi’s plea in favour of budgetary expansion in countries with fiscal space. Simulations show that spillover effects to other eurozone countries would be small. Moreover, the implementation of a fiscal package requires long preparation and may be hampered by labour shortages.

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Decision

Fed and ECB: diverging approaches to monetary policy

The Federal Reserve and the ECB are in very different positions: the former has more room to ease policy and it is also closer to its policy targets. The ECB has limited remaining policy leeway but is confronted with an inflation shortfall versus its aim and a risk that this gap would increase, rather than narrow. These differences have led to diverging approaches in the conduct of and communication about monetary policy. The Fed is data-dependent and, except for the projections of the FOMC members, offers no guidance. The ECB is agnostic about the data and builds its communication around state-dependent forward guidance: policy tightening will be solely conditioned by meeting its target. The ECB stance reduces the sensitivity of financial markets to data surprises whereas the Fed stance increases it. This implies a risk of higher volatility in the US but also, via international spillovers, abroad.

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ECB

ECB: Mario Draghi passes the baton

Market expectations were elevated but the Governing Council did not disappoint. The comprehensive nature of the package, with the introduction of state-dependent forward guidance, take away the need to envisage additional measures in the foreseeable future. ECB watching has been narrowed to monitoring the gap between inflation and the ECB target. Given certain negative side effects of the current monetary mix, which are acknowledged by the Governing Council, fiscal policy, where leeway is available, is now requested to step up to the plate, so as to foster growth and speed up convergence of inflation to target. The policy baton has been passed

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ECB: committed to ease in September, but how much

ECB: committed to ease in September, but how much?

The Governing Council has tasked Eurosystem committees to examine its monetary policy options. Given the insistence on its determination to act, Thursday’s meeting outcome was basically a pre-announcement of easing in September. Being aware of the importance of maintaining the ECB’s inflation targeting credibility, Mario Draghi was very explicit in expressing his dissatisfaction with current inflation and its outlook, adding that a highly accomodative monetary policy is here to stay for a long period of time

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full employment

Monetary easing at full employment: how effective?

Fed Chairman Powell, in his address to Congress this week, has confirmed that easing is coming. In June, ECB President Draghi provided similar hints. This comes on the back of growing concerns regarding global growth and ultimately facing too low a level of inflation. Risks may be mounting, but, on the other hand, the unemployment rate is close to the natural rate. There are reasons to assume that monetary easing under full employment would be less effective than when the economy is marred in recession. Monetary easing could also raise concerns about financial stability, which, if unaddressed, could weigh on the ability of monetary policy to successfully boost inflation.

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monetary policy

Exogenous versus endogenous uncertainty and monetary policy

A high level of uncertainty can act as a drag on growth. Whether monetary easing will succeed in boosting growth will depend on the nature of uncertainty. Endogenous uncertainty follows from the normal development of the business cycle and rate cuts should succeed in reducing this uncertainty by boosting confidence of economic agents. Exogenous uncertainty is not driven by the business cycle but is triggered by other factors, such as, in the current environment, ongoing trade disputes. In this case, monetary policy effectiveness suffers and, despite rate cuts, the growth slowdown should continue until its root cause (exogenous uncertainty) is addressed.

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William De Vijlder June 2019

Soft landings are difficult, even more so today

The Fed has turned the corner and is now looking towards moving into easing mode. Low inflation makes this possible, slowing growth and significant external headwinds make it a necessity. However, the track record of successful soft landings is poor. In the current environment, the challenge is considerable given already low rates in a very mature expansion. The biggest issue however is uncertainty with respect to trade.

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bank

Central banks: synchronised swimming against the tide

ECB President Mario Draghi, speaking at Sintra, has raised expectations of renewed policy easing. The message from the FOMC meeting is that rate cuts are coming. This policy synchronisation reflects shared issues (inflation too low versus target) and shared concerns, the major being rising uncertainty. Should this continue, the effectiveness of monetary accomodation will suffer.

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public finance

Growth, interest rates and government debt

The relationships between government debt, economic growth and interest rates are complex and varied. In general, a recession causes an increase in government debt and a decline in government borrowing costs. A prolonged period of monetary accommodation during a cyclical upswing can cause the average nominal interest rate on government debt to drop below the rate of nominal GDP growth. Depending on the level of the primary balance, such a situation can, under certain conditions, create leeway for fiscal expansion in order to support growth.

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ECB

ECB: easing of inflation raises pressure

The pass-through of wage growth to prices is stronger and faster when inflation is higher to start with. The low inflation in the Eurozone has slowed down the transmission. The considerable growth slowdown, on the back of adverse foreign demand and uncertainty shocks, impairs this process even more. This raises pressure on the ECB to take action in order to dislodge core inflation, which remains stuck well below its objective.

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US

US: Three different messages from Washington DC

President Trump has argued that the US economy would get a boost if the Federal Reserve were to cut rates. The minutes of the FOMC show the members are confident about the growth outlook. The outlook for inflation, against a background of global uncertainties, allows them to be patient in terms of policy. The IMF in its latest Global Financial Stability Report expresses concern about how high debt levels weigh on the resilience when faced with significantly slower growth or higher borrowing costs. This implies that Fed policy will not only be confidently patient but also patiently vigilant.

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dollar

Federal Reserve: Monetary policy self-assessment

The Federal Reserve will conduct a review of its monetary policy framework and the conclusions will be made public in the first half of 2020. Three questions will be addressed: should the monetary policy stance take into account past misses of the inflation objective? Are the tools adequate? How can communication be improved? The initiative should be welcomed because it shows the Fed’s efforts for being ready when the next recession hits. Facing similar challenges, the ECB is likely to be interested in the outcome of the Fed research.

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decision

US: Fed turning a corner, but into which direction?

Although US growth remains strong, global headwinds, softer survey data and tighter financial conditions have put the FOMC in risk management mode. Policy remains data dependent, but a patient stance will be adopted before deciding on the next move in monetary policy Inflation, which remains well under control, facilitates this wait-and-see attitude. Markets are now pricing in a policy easing in the course of 2020. More than anything else, this shows to which extent uncertainty has taken its toll on confidence.

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crisis

United States: The Powell put

Fed chairman Powell has recently emphasized that the FOMC will be patient given the muted inflation reading and that it is ready to shift the policy stance swiftly if required. He also considers that financial markets are pricing in downside risks well ahead of the data. This means that they are too pessimistic on growth Professional forecasters’ estimates of the probability of entering into recession in the coming quarters do not display the typical pre-recession dynamics either.

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ECB

ECB: From quantitative easing to quantitative pausing

As expected, the ECB Governing Council has decided to end the net purchases in the context of its asset purchase program. This new phase can be called quantitative pausing, before eventually moving to quantitative tightening, i.e. to shrink the size of the balance sheet. The end of net purchases increases the role of forward guidance as an instrument to control interest rate expectations. The enhanced forward guidance, i.e. continuing to reinvest for an extended period past the first rate hike, should be welcomed.

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resilience

Eurozone: Strengthening resilience

Support seems to be growing for the proposal of France and Germany for a eurozone budget. This would contribute to a much needed enhancement of economic resilience, that is the ability to cope with shocks. Resilience can also be strengthened through private and public risk sharing and policies seeking to boost potential growth. Boosting resilience is all the more important considering that risks to global growth seem to be tilted to the downside.

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