Must-Read: Matthew Klein: Some Fed Thoughts: QE4 and All That

Must-Read: Matthew Klein: Some Fed thoughts: QE4 and All That: “For months, the mid-September meeting of the Federal Open Market Committee was being telegraphed as the most likely start date of the ‘normalisation’ process…

…the day when short-term interest rates would begin ‘liftoff’ from the current range of zero to 25 basis points…. [But] when you have bond yields plunging, corporate spreads widening (even excluding energy and mining), stock prices falling, and commodities (except gold) collapsing, it’s possible there is useful information for central bankers to consider… [plus] the changes in asset prices amounted to a tightening….

Which brings us to Ray Dalio’s latest missive…. Dalio’s actual position doesn’t strike us as obviously unreasonable… that the dynamics affecting the transmission of monetary policy… are different… [and] the future path of short-term interest rates will be shallower than the dots…. This view isn’t necessarily that different from what’s implied by market prices…. It’s pretty easy to justify the current yield on the 10-year note (a little more than 2 per cent) by imagining a world where 1-year rates top out around 5 per cent by 2019, stay there until 2020, and then plunge back toward zero by 2022…. 1) recessions always happen sooner or later, 2) not having a downturn for a total of 16 years would be basically unprecedented in the American experience, and 3) cutting rates from a peak probably no higher than 4 per cent almost certainly means bumping up against the zero bound relatively quickly….

The pessimistic interpretation, which we believe is consistent with what Dalio wrote and what is implied by market prices, is that most of the rich world just doesn’t grow that much unless households and businesses are boosting their debt and eating into their savings…. Unless we get a 1940s-style reflation that wipes away private debt burdens and makes future releveraging possible… any significant cutback in monetary stimulus will quickly cause the economy to sink from steady but mediocre growth into stagnation and then outright recession…. We have no strong view on who’s right, although if forced to choose, we’d side with market prices over central bankers…. Better, though, to avoid the entire argument by having a responsible fiscal policy that lets the private sector deleverage, as in the 1940s…

August 30, 2015

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