It’s June, and I’m in Washington DC; the sky is blue, and the temperature outside is in the low 70s. Oh, and stock markets around the world are soaring. This is as good as it gets.
With Europe on the brink of the abyss, and all the gloom and doom of the past month, is there really cause for optimism? I don’t know, but Scott Sumner got all excited yesterday about signs that people are finally starting to get it, especially this piece by Matthew O’Brien posted on the Atlantic website. Optimism seems to be catching, at least on the stock market.
There does seem to be a growing understanding that the conventional way of thinking about how monetary policy works – increasing the quantity of money causes interest rates to fall, inducing increased spending by business and households – is misleading, especially when interest rates are already close to zero. Instead, the way to think about the money supply is that the monetary authority ties its creation of money to a price or spending target. But for monetary policy to work in this way, the monetary authority has to announce, or at least make clear, that its policy is subordinate to the target it is aiming at, so that the public can revise its expectations accordingly. When the public’s expectations change in the appropriate direction, the battle is more than half won; the rest is a mopping up operation.
Also worthy of mention (a huge understatement BTW) are three recent posts by the precocious Evan Soltas (on monetary policy in Switzerland here and here and on monetary policy in Israel) which beautifully illustrate points that Scott and others have been making with little effect (on policy) since 2009. The voices crying out for a different approach to monetary policy are no longer lonely, and no longer in the wilderness. (And while handing out plaudits, I’ll just mention my own post about Switzerland back in September).
And here’s what one story (“Dow Surges on Stimulus Expectations”) says about the world-wide rise in stock markets today:
U.S. stocks were soaring Wednesday morning as investors rushed in from the sidelines on hopes the Federal Reserve could soon signal it’s open to additional stimulus measures.
The Dow Jones Industrial Average was rising 178 points, or 1.5%, at 12,306. The move puts the blue-chip index back in positive territory for the year.
Within the S&P 500, 95% of components were on the rise.
Gainers were outpacing decliners by a 7-to-1 ratio on the New York Stock Exchange and 4-to-1 on the Nasdaq. The leading sectors were basic materials, capital goods and energy.
The European Central Bank said Wednesday that it was keeping its benchmark interest rate at 1%. However, the markets continued to look for clues that the central bank would show an openness to lowering rates by July in the face of growing signs of recession on the continent and Spain’s troubled banking system.
“There is a necessity for them to show their cards when conditions turn urgent,” said Geoffrey Yu, analyst at UBS.
After the meeting, ECB President Mario Draghi indicated that short-term liquidity measures would continue but withheld clues on more aggressive plans to tackle the debt crisis.
“Today, we have decided to continue conducting our main refinancing operations as fixed rate tender procedures with full allotment for as long as necessary, and at least until … January,” Draghi said at a press briefing.
Federal Reserve Chairman Ben Bernanke testifies before Congress on Thursday, and it will be his first opportunity to comment on the weak jobs report last Friday. Given that the benchmark interest rate in the U.S. is already at a record low, the market will look for clues that the central bank could embark on a third round of quantitative easing.
The FTSE in London was rising 1.9% and the DAX in Germany was gaining 1.6%.
Maybe things really are darkest just before the dawn. We may be in for a long hot summer in Washington, but today I will enjoy the good weather and blue sky while it lasts. I sure hope Bernanke doesn’t spoil it all tomorrow.