Let me be one of the first to welcome Captain Poloz and his spacecraft the HMS BoC back to reality from their recent intra galactic voyage. The Bank’s latest version of the MPR seems to be more in tune with our world. They finally acknowledged a number of data points that had been read by us earthlings as actually occurring but until this week appeared to be largely ignored by our monetary masters. Don’t get me wrong, they are still claiming some economic relationships that may work only in zero gravity, but overall they have touched down, however briefly, and joined us in reality.
First, let’s look at their log book that recorded observations when the ship’s wheels hit the tarmac. They acknowledged that growth had come in much stronger than they were expecting when they left in January. The oil and gas sector getting up off its knees, strong demand for autos and, of course, an out of control housing market contributed to a surge in activity. First quarter growth is now strong enough to give the Governing Council enough fortitude to say that interest rate cuts are now off the table. The Governor during the press conference even said that the recent economic data was good news. Now if he would only look like he meant it.
Once they landed they also noted the housing market in the GTA and, given their reading off their price increase meter located on the bridge, concluded that there may be some speculation going on in the region. They went as far as to include the housing market as a near term positive risk to inflation and to admit that it could also potentially create a macro and financial vulnerability in the future.
Alas, this was all too much good news for them. After admitting that economy is in a better place, they quickly reverted to their suck and blow approach to keeping financial conditions accommodative. Before anyone should get excited about the possibility of increased rates or a stronger dollar as a result of a higher starting position, they stressed that they believe that the recent surge in growth and inflation are just temporary. From now on, everything is down hill. The material excess capacity in the economy will be slow to absorb and until every young adult leaves their parents’ basement and finds gainful employment you will have Captain Poloz keeping the shields up and continuing to demand lasers be targeted at non energy exports and be set on accommodation. GC concluded, after pulling a new rabbit out of their hat with respect to potential growth, that the output gap will not close until the first half of 2018, ever so slightly sooner than envisioned in January. Their message: Everybody calm down and buckle up in preparation for serial disappointment.
Confusingly for us, when they create a narrative, they continue to defer to the economics text book they picked up while visiting Uranus University (known as U2 to the alum) on the transmission of monetary policy in zero gravity. Economic relationships that apparently are theoretically robust in space, but don’t seem to be consistent with what most of us on earth deem to be reality. According to profs at UU, interest rates have no impact on the housing market (or colonies). Hell, as the Governor told us several times, rates could go to 5% and still not have an impact. Those darn speculators are immune. I remember in economics classes taken on earth, we were always taught that as a result of leverage, the housing market was one of the most interest rate sensitive sectors. As a result, I am still going to believe an increase in rates would have some impact in cooling the housing market. But again, a different world.
More fascinating in zero gravity is that changes in interest rates apparently can have very concentrated effects. In space, changes in rates have no impact on housing investment but do leave an impression on other components of growth, including business investment. The MPR tells us that the only sources of growth we have to look forward to in the near term will be household spending which will be supported by accommodative monetary policy (except, I guess, for anything to do with housing which is unresponsive to rates) and fiscal stimulus. The next time GC departs into space, I hope further work will be done studying the elasticity of certain sectors to changes in rates. Maybe try to understand why in space, rates can rise by 5% and have no impact on a bubbling housing market while at the same time business investment, which we are told is partially paralyzed by uncertainty around US trade measures, is hyper sensitive to the downside given even the slightest hint of a rate increase. On this planet, it wouldn’t matter to business investment if rates went higher. It would be like stabbing two day old road kill.
And while the crew is up there, they should track down the financial market literature on the role of “chunks” in dampening financial asset bubbles. Even without gravity apparently some things can still go down. The theory apparently states that since the speculator has to buy the entire house, as prices go ever higher he/she will be unable to muster up sufficient funds to either buy a house or find a buyer who has the financing for the house he/she is trying to flip. The market then falls under its own weight. On earth what we are seeing as prices are going through the roof are speculators banding together and splitting any profits. What we have is the price (known in space as “chunk”) divided by however many speculators want to be involved. Suddenly the chunks are small again. Heck, in the 905 region around Toronto, families are combining their incomes to buy one home to live in permanently together. Having said this, it would be great to get a hold of the work done so we can be better prepared. The last thing we all want to see is a market blowing out chunks.
The Governor concluded the MPR saying that they are now decidedly neutral. The market seemed to view the acknowledgement of the stronger data as slightly hawkish. With the captain of the spaceship convinced that there is excess capacity, and emboldened by low readings of core inflation, economic theories taken from both our world and from their travels will be used to create a narrative to justify extremely accommodative policy. This is a captain a few years into his seven year mission who is nobly focussed on getting as many people working as he can before the asset bubbles he has created come crashing down on top of him. He is going where no man sitting in his chair has gone before—unemployment below its natural rate (NAIRU).
No comments:
Post a Comment