James Alexander/Feb 18, 2016
Call me a conspiracy theorist but when three unrelated beasts of the global financial establishment all start talking about the same, previously unfashionable, thing it’s a bit of a coincidence. Maybe Larry’s put it in the agenda of next week’s G20? If it’s not, it should be.
The MPC have revised down their forecast for real GDP growth and CPI inflation in the short term, implying weaker nominal growth. This, combined with threats from the international environment, mean we face the risk of a weaker outlook for nominal GDP. If realised this could present challenges for tax receipts in the future, and reinforces the importance of delivering our plan to achieve a surplus on the public finances by the end of the Parliament.
3. Cut rates back to near-zero and strong guidance: if the equity market drops into a full bear market (or there is some other equivalent financial tightening) or if growth seems to be slowing to a sustained 1%, the Fed would likely cut and remain on hold until the financial/economic weakness reverses. They could introduce a nominal income growth target or price level target to signal an accommodative path for rates well into the future.
But monetary-policy makers need to acknowledge much more explicitly that neutral real rates have fallen substantially and that the task now is to adjust policy accordingly. This could include setting targets for nominal GDP growth rather than inflation, investing in a wider range of risk assets, making plans to allow base rates to turn negative, and underscoring the importance of avoiding a new recession.