MacroScope

Ann Saphir contributed to this post

Minneapolis Federal Reserve President Narayana Kocherlakota has gone from being one of the U.S. central bank’s more hawkish characters to arguably its most dovish. In line with this transformation, Kocherlakota told a conference sponsored by the University of Chicago’s Booth School of Business that the Fed, despite its extensive bond-buying over the last few years, has not done enough to spur growth.

The FOMC has responded to this challenge by providing a historically unprecedented amount of monetary accommodation. But the outlook for prices and employment is that they will remain too low over the next two to three years relative to the FOMC’s objectives. Despite its actions, the FOMC has still not lowered the real interest rate sufficiently in light of the changes in asset demand and asset supply that I’ve described.

To get a sense of what he means, see the graphs below: U.S. inflation continues to undershoot the Fed’s 2 percent target, and is actually drifting lower, while unemployment, though down from crisis peaks, remains stubbornly high.

Vincent Reinhart, Morgan Stanley’s chief U.S. economist and a former senior official at the Fed’s Board, even used the dreaded d-word in his latest research note to clients.

With evidence building that the Q2 soft patch is upon us, worrisome chatter about deflation is taking center stage. Our outlook for some time has been that mounting fiscal drag would show through in Q2 most strongly as sequester effects take hold and a slowdown in global trade hits U.S. shores. Indeed, another run of poor data this week has shown spring growth may be dampened by weakness in manufacturing, increasing jobless claims, and a stalling housing recovery. The slowdown in activity is not helping the Fed with their consistently significant misses on the employment side of their mandate, but it now appears they may have to turn their attention to supporting inflation from the bottom.

All the talk of currency wars is mostly just that – talk. This week’s meeting of the Group of 20 nations at the International Monetary Fund was living proof. Despite speculation that emerging nations would redouble their criticism of extraordinarily low rates in advanced economies, the G20 ended up largely supporting the Bank of Japan’s new and bold stimulus efforts aimed at combating years of deflation.

Mr. currency wars himself, Brazilian Finance Minister Guido Mantega, told reporters Japan’s monetary drive was understandable given its struggle with falling prices and stagnant wages, even if he called for close monitoring of its potential spillover effects.

Outgoing Bank of Canada Governor Mark Carney said Japan’s action is consistent with the G20 communiqué that called for countries to refrain from competitive devaluation. Carney, the head of the G20′s Financial Stability Board, takes over the Bank of England in July. His comments echo recent remarks from Fed Vice Chair Janet Yellen.

Worries about potential side-effects of unconventional monetary policy on financial markets are at least exaggerated, if not a near figment of the imagination.

This appears to be the conclusion of a comprehensively-argued research note by Bank of America Merrill Lynch global economist Ethan Harris.

The risk investors need to focus on is disinflation, not inflation; yet, remarkably, over the last several years critics of the Federal Reserve’s quantitative easing have “hijacked” the inflation debate, Harris says.

This post was based on reporting by Leika Kihara in Tokyo

Japan has crossed the monetary rubicon: the government is actively intervening in the affairs of the central bank, pressuring it to more aggressively tackle a prolonged bout of deflation and economic stagnation. The Bank of Japan is expected to discuss raising its inflation target from the current 1 percent level during its next rate decision on January 21-22.

Overnight, a Japanese newspaper reported the finance ministry and the central bank were considering signing a policy accord that would set as a common goal not just achieving 2 percent inflation but also steady job growth.

Key Japanese policymakers played down the prospect of making the BOJ responsible for stable employment like the U.S. Federal Reserve, but said a 2 percent inflation target will be at the heart of a new policy accord with the central bank.

The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:

It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.

Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:

Economist Douglas Irwin of Dartmouth College has stirred up a bit of a fuss by concluding in some academic research that it was France, not the United States, that was most to blame for The Great Depression.

Irwin’s theory, in a paper posted here by the National Bureau of Economic Research, is that France created an artificial shortage of gold reserves when it increased its share from 7 percent to 27 percent between 1927 and 1932.  Because major currencies at the time were backed by gold under the Gold Standard, this put other countries under enormous deflationary pressure.

To prove his point, Irwin ran a model looking at what would have happened without the French move. The results:

A look at the macroeconomic news and its impact on the mood of investors and the direction of the economy. Are we heading for a double-dip recession?

The housing market is more closely related to the price of luxury items than staple goods such as food and clothing, reports David Leonhardt in the NYT. This being the case, don’t treat your home like an investment because the forecast is underwhelming.

But all is not doom and gloom in the housing sector. In is blog Jeff Matthews Is Not Making This Up, Mathhews espouses the “Cover Story Syndrome” method of investing. The seeds of a housing market recovery have been planted by this week’s Time magazine cover story on just how bad things are, according to Matthews.

While most of the developed world frets about deflation, in Britain, inflation just won’t quit. 

The Bank of England has been forecasting a sharp fall in consumer price inflation for about as long as Britons have hoped for a summer of uninterrupted sunshine. But at least Britons are still betting on a fair amount of rain. 

UK inflation was 3.2 percent in June, a slight fall from the month before, but still 1.2 percentage points above the central bank’s target rate. 

The recent spate of shark attacks on Australian beaches could mark a turning point in global deflation and signal a change in fortunes for some beleaguered emerging economies, if Nomura strategist Sean Darby is to be believed.

Speaking at a Nomura investors forum, Darby said a chance sighting of a shark on Sydney's famed Bondi Beach three weeks ago made him realise that prices of grain and other soft commodities -- punished of late by global recession fears -- could be due for a rebound.

"I actually saw a shark on Bondi Beach and that made me wonder about the impact of La Nina and how there's a severe drought around the world at a time when many farmers are finding it hard to access credit," said the Hong Kong-based analyst.

Merrill Lynch economist David Rosenberg’s views are well-known for bearing no resemblance to his firm’s trademark bull, so when he says European clients seem too upbeat, what he really means is they weren’t thoroughly depressed. The New York-based economist just got back from a marketing trip across the Atlantic and didn’t find much common ground.

In particular, he said European clients seemed more concerned about inflation than the deflation that he sees coming, and they may have unrealistically high expectations for President Barack Obama.

“Unbelievably … portfolio managers seem to think they are taking a bigger risk with their careers by missing the rallies than by missing the sell-offs,” he wrote in a note to clients. “I can tell you that this is not a condition from a sentiment standpoint that terminates bear markets.”