Anatole Kaletsky

Yellen looks toward a Keynesian approach

Anatole Kaletsky
Feb 13, 2014 19:18 UTC

This has been a banner week for the world economy, inspired largely by events in the United States.

In Washington, the first congressional testimony from Janet Yellen in her position as new Federal Reserve Board chairwoman reassured and impressed two notoriously petulant audiences: Tea Party congressmen, who had assembled a posse of hostile witnesses to attack the Fed’s “easy money” policies; and panicky Wall Street investors, who had spent the previous month swooning on fears that monetary policies might not be easy enough.

The significance of Yellen’s testimony lay not in the fact that she was a bit more “dovish” than former Chairman Ben Bernanke, or seemed more committed to the new central bankers’ fad for “forward guidance,” as opposed to “quantitative easing.” More striking, if subtle, was the change in economic philosophy that Yellen represented.

Bernanke, despite his radicalism during the financial crisis, was philosophically an orthodox monetarist, who followed his mentor Milton Friedman in believing that the main job of a central bank is to stabilize inflation. For monetarists, consistently hitting an inflation target is, in normal circumstances, a sufficient criterion of monetary policy success. They believe that using monetary policy for other economic objectives, such as stimulating growth or creating jobs, is doomed to failure and ultimately leads to galloping inflation.

Once inflation is stabilized, monetarists explain, the “real” economy should be left to market forces. These determine the optimal levels of unemployment and growth that a low-inflation economy can achieve.

Europe has lost its ability to surprise

Anatole Kaletsky
Jul 4, 2012 19:31 UTC

Last Friday global stock markets and the euro enjoyed their biggest one-day gains of the year. The S&P 500 jumped by 2.5 percent and the euro by 1.8 percent against the dollar. This Friday we will find out whether these moves were just a blip. Why this Friday? Because that is when the U.S. government publishes its monthly employment statistics – and these figures have more influence on global markets than anything that European leaders may or may not decide.

There are four reasons to believe this. The first is the very fact that Europe so dominates the news. Financial markets are not moved by events; they are moved by unexpected events. Once a story has appeared on newspaper front pages around the world every day for months, what are the chances that it will radically surprise? At this time last year, there was still widespread misunderstanding and complacency about the European crisis. The European Central Bank, for example, was so complacent that it was raising interest rates when it should have been cutting them. But today, investors and policymakers are obsessed with Europe’s grim prospects. A genuine surprise would have to be something much worse, or much better, than the scenarios market participants already know.

This observation leads to the second reason for shifting attention from Europe. For Europe to generate a favorable surprise that lasts for more than a few days or weeks is literally impossible. The market is too aware that for the euro to survive it has to go through a  lengthy and uncertain process of political federation. But Europe’s capacity for negative surprise is quite limited too. Everybody knows that Europe is in deep recession, that Greece will never repay its debts, that Spanish banks are insolvent, that debtor countries will all miss their budget targets and that German-imposed austerity will prolong the recession for years. The only news from Europe that would shock the markets would be a total breakup of the euro and Lehman-style financial meltdown. Such a breakup is possible, but it isn’t yet the most likely scenario. Unless a breakup happens, Europe will create lots of volatility, but the trend in financial markets will be set by events elsewhere.