The Weekly Report

By: Mick P | Sat, Apr 12, 2008
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Welcome to a Weekly Report special, incorporating further discussion of last weeks Occasional Letter.

This week we look at an example of Eggertsson Theory in practise, what really worries the Fed and what is their favourite import, how expectations can be managed, why General Electric are going to struggle and I announce something a little different. A lot to cover and I am pressed for time so let's get on with it.

The Bank of England Applies Eggertsson Theory - An Example

For background please read this article The Future Actions of The Federal Reserve And US Govt Are Known in which I assert that the Federal Reserve is applying a monetarist/Friedman solution, formalized in a theory put forward by G B Eggertsson in The Deflation Bias and Committing to Being Irresponsible.

I have been watching for signs that other Central Banks may also be applying similar methods in an attempt to offset deflationary tendencies and the Bank of England (BofE) duly obliged:

It's the type of action undertaken by the Federal Reserve on a now routine basis and since September '07 has become a rolling monthly programme for the BofE. As we can see from the figures above the lending requirement is heavily concentrated in the 3 month maturity window, helping to alleviate strains in longer maturity money markets.

So we see stage one of an Eggertsson Theory based currency infusion into the Banking system. However as Eggertsson pointed out we need to see an increase in Government debt to raise expectations that a credible attempt is being made to inflate.

This is from the aptly named United Kingdom Debt Management Office:

So, here is the second stage, the creation of Govt debt to facilitate the use of the BofE largesse. Here is the definition of delivery-by-value:

You can, as a Crest member, swap the 3 month maturity BofE cash for Treasuries that will be available for.....3 months. The cash issued has been collateralised against newly created Govt debt.

Now to ensure this is seen as an inflationary move, we need rhetoric from the BofE who are in charge of the attempts to meet the 2% inflation target rule.

As if by magic the BofE excels itself (I will underline the inflationary bias):

It is a stunning piece of work and effective on so many levels as the stage three requirement in Eggertsson's Theory. It would take a huge "volte face" by a non-Austrian based economist to find fault with the reasoning. Yet it is deeply self-contradictory.

Seeing statements like those above, you could have been forgiven for thinking rates should stay at 5.25% or maybe go higher. The expectation is for higher inflation linked (by the BofE) to rising prices and depreciation in sterling.

The reasoning for the rate cut is beautiful:

After all the emphasis on the inflation target and the possibility of overshooting, here we get the opposite. Now it is clear that a target of 2% is desirable, indeed it is essential. Any threat that allows the possibility of inflation being below 2% must be combated.

Notice the committee expect inflation to rise further this year, yet their actions are dictated by the possible slowdown of the economy and a specific mention about the lack of available credit (which is the same as "disruption in the financial markets"). It is the expected slowdown in growth and an increase in spare capacity (unemployment up, capacity utilization down) that will keep inflationary pressures in check.

I'll put it this way. If you feel you need to cut rates, engendering an inflationary expectation and are then relying on a recession or slowdown to keep inflation in check at a lower level, you are not really expecting inflationary forces in the medium term.

The BofE is encouraging higher inflation (by cutting rates and raising rhetoric) to offset deflationary symptoms that they do not wish to acknowledge in the statement or wish to have discussed openly.

This is an attempt to front run deflation. The giveaway is this snippet:

It is extremely unusual for the BofE to clarify the difference between high prices and inflation. It is probably the closest they will come to acknowledging the deflationary forces unleashed by the collapse of credit markets.

Is this policy succeeding, do we have evidence that inflation expectations are being driven higher by "credible actions"?

Quite possibly we do and current actions by the BofE can only reinforce such expectations. The following is from Finfacts, reported on 13th March:

If you want to see how much media interest there is, type "UK inflation expectations" into google. Then compare it to typing in "UK deflation expectations".

Is the Federal Reserve achieving the same result as it talks up inflation and appears to be credibly inflating along with the US Govt? Here is the latest University of Michigan Sentiment Index readings:

These are some of the worst readings since 1982. But notice, amongst all the gloom, the huge move higher in inflation expectations. The Fed and US Govt actions are being seen as credible. Yet, what of consumer spending? Is the Fed engendering a "spend now because it will be more expensive tomorrow" attitude?

Are the consumers in the RBC index feeling confident about purchases?

To read the rest of the Weekly Report and visit my new website, click here.



Mick P

Author: Mick P

Mick P (Collection Agency)
About Collection Agency

An Occasional Letter From The Collection Agency in association with Live Charts UK.

For some years now I have written an ongoing letter, using macro-economics, to try and peer into the economic future 6 to 18 months ahead. The letter was posted on a financial bulletin board to allow others discuss its topic.The letter contains no recommendations to buy or sell, indeed I leave that to all the other letters out there and to the readers own judgement. The letter is designed to make us all think about what may be coming, what macro trends are occurring and how that will affect future trends and how those trends will filter down to everyday life and help spot weak or strong areas to focus on for trading or investing.

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