Must-Read: Matt O’Brien: Europe Just Made It Harder for the Fed to Raise Rates

Matt O’Brien: Europe Just Made It Harder for the Fed to Raise Rates: “Europe is going to have zero interest rates for a lot longer…

…that is going to make it harder for the United States to stop having them…. The ECB seems set to do something at its December meeting to try to prevent the emerging market slowdown from spilling over into Europe and get inflation moving back up toward its 2 percent target. It that sounds familiar, that’s because it is. Those are the same problems the U.S. has now. But instead of thinking about new ways to stimulate the economy, the Federal Reserve is getting ready to do less. Why? Well, unemployment is half as high here as it is in Europe, so there should be more upward pressure on inflation. Look at that last sentence again, though. That’s a lot of faith to put in one of the most dangerous words in the English language–should–when the cost of being wrong is so high. Indeed, inflation isn’t increasing at all now even though unemployment is down to a pretty normal level….

Consider this: according to Goldman Sachs, just talking about raising rates has already tightened financial conditions as if the Fed had actually raised them around three times. And that was when the ECB was only buying 60 billion euros of bonds a month. It’d be even more of a problem if it was buying more…. If two monetary policies diverge even more in, well, not a wood, we might take the path every other country that has tried to raise rates from zero has traveled by–back to where we started.

Katie Martin: Dovish Mario Draghi sends bond yields to new lows: “Yields on two-year debt now stand below zero for almost every member of the eurozone…

…Investors have been piling into eurozone debt since a press conference on Thursday at which ECB president Mario Draghi suggested further cuts to the deposit rate could be on the way. The deposit rate already stands at minus 0.2 per cent…. The ECB has already been buying an average of €60bn a month since March, mostly in government bonds, and intends to continue that programme until at least September next year. But investors now think the programme could last longer, encompass more instruments or grow in size…. Economists think the euro weakness that would inevitably accompany a fresh bout of easing from the ECB will create headaches for other central banks in the region.
Swedish bank SEB wrote on Friday that the prospect of further easing is ‘a nightmare’ for the Riksbank, which already has interest rates at rock bottom to try and support inflation. Renewed strength in the krona, the flip side of weakness in the euro, would probably depress consumer prices still further.

October 26, 2015


Brad DeLong
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