James Alexander | At football matches in England there is always a particularly hurtful chant that goes up around the ground when a team, a player or a referee is doing badly. They are very often compared to some team or referee or player whom everyone knows is far worse. It is sung to the tune of a famous hymn, like many football songs, “Guide me, O thou great redeemer”. Janet Yellen’s record so far as Chairman of the Fed reminds of this chant, and particularly Jean-Claude Trichet’s penultimate year (mis)guiding the ECB.
13th July 2011 should go down as a day of infamy in the Euro Area. It was date of the second rate rise by the ECB that year, that tanked markets and led more or less directly to a dramatic liquidity squeeze for Euro Area banks, and caused the plunge into the second part of the Area’s double dip recession.
We all now know that Euro Area troubles started in 2008 when the world was plunged into the Great Recession by pro-cyclical monetary tightening by various central banks, just as NGDP growth expectations were falling rapidly at the time of the Lehman default. A lot of other stuff was going on, for sure, but it was noise compared to the core monetary story.
The US and Europe had already spent two hard years escaping from the consequences of the 2008 tightening. Then, in an attempt to out-macho the US and impress the selfish German establishment, the ECB under Trichet decided to stamp on headline inflation hitting nearly 3% in early 2011, while core remained solidly below 2%. The ECB therefore directly smashed the early stages of recovery with a heavy tightening bias and two rate rises. The different paths of the two big currency blocs has been very well documented here with a good summary here.
Trichet and those two ECB 2011 rate rises
The first of the rate rises that year on 3th April 2011 did not cause undue damage. 1Q11 Euro Area NGDP had almost hit the dizzying 3.9% YoY. Within the Area German NGDP was at 6.4% YoY that quarter. This was too strong for Germany and so they pressed for a tightening and Trichet was only too happy to oblige, forgetting about the rest of the Euro Area, especially the periphery. In that quarter Spain and Portugal were already enduring marginally negative NGDP growth. Yes, they were in outright deflation but had their monetary policy tightened substantially – it seems really crazy the more you think about it. Greece had very negative NGDP YoY at -9%.
Never mind, the selfish, almost anti-European, old DM/German bloc anti-growth bias had to be appeased. Actually, it was even worse, Trichet was actually rather fanatical in thinking he was doing the right thing for the Euro Area as a whole. It was his final goodbye press conference that made me rethink my priors. He was forced to defend what havoc he’d caused by trying to claim credit for giving the Euro Area a lower inflation rate than Germany had experienced prior to the Euro – and hang the consequences of a double dip recession. It was all deeply personal and subjective. Central bankers can do no wrong and certainly cannot take criticism.
Well, the rest is history. The Euro Area slowed during 2Q11, as you’d expect from such a tightening of monetary policy. Although the Euro Area stock markets merely drifted, NGDP growth fell to 2.9%. The stock market drift may have lulled Trichet and his ECB into a false sense of confidence.
As expectations for NGDP growth dropped further, they made their second fateful move. Stocks tanked within days, the banking crisis re-erupted, engulfing the French bank SocGen in particular. NGDP fell to 2.4% during 3Q and carried out on down. It was too late, the damage had been done and the cycle was hard to turn.
Market response to April 2011 ECB rate similar to December 2015 Fed rise
We often see articles and blogs wondering whether the US rate rise in late 2015 will end up forcing the country to re-live the great 1937 stumble in the recovery from the Great Depression when monetary policy was tightened too early. The Euro Area from 2011 seems far more apt, and fresh in our memories. A slow recovery, with a few hot spots, was stamped on by two rate rises amidst a severe tightening bias. Rates ended up falling, of course. The first rate rise was seen by the markets as almost manageable, or rather it was met with a degree of sang froid. The second seemed mad given where NGDP expectations had tumbled.
The December 2015 rate rise seemed to be met with a similar sang froid, after all it had been expected for months. Some, particularly market Monetarists, had warned of the dangers of the monetary tightening and thought actual and expected NGDP growth too weak to cope. The market sang froid was probably mistaken by the Fed as an acceptance that its full-blown “normalisation” programme could proceed as they planned. Vice-Chairman Stanley Fischer’s now notorious 6th January interview on CNBC, especially his articulation that four more rate rises this year was “in the ballpark”.
Economic news has been poor since then, reflecting the impact of the 2015 monetary tightening, and now expectations are falling. The question remains: Is Janet Yellen Jean-Claude Trichet in disguise? Will she take some market tranquillity as a justification for a second rate rise? Maybe. Just how much does she fear inflation rising to the Fed’s forecast of 2%, how stubborn will she be in pursuing her “normalisation” programme come what may?
“You don’t know what you’re doing”
When the team, referee or player continue to invite really bad comparisons the football fans often switch to an even more hurtful chant, “you don’t know what you’re doing, you don’t know what you’re doing”. It is sung to the tune of “Que sera, sera” (whatever will be, will be). Fatalistic, but apt.