For countries with no fiscal firepower left and interest rates at zero, quietly devaluing in the guise of stimulus is the only tool left in the box.
The Reserve Bank of Australia follows the commendable practice of scattering what it calls boxes throughout the main text of its regular reports on monetary policy. These breakout boxes focus on particular, often highly significant developments in current policy formulation.
In its latest publication the RBA has published a box bearing the description: "The Decline in Bond Yields and Inflation Expectations". Hardly arresting, but these issues are destined to determine global economic performance through 2015 and beyond. Note the word, global.
Before the global financial crisis these were policy areas regulated by country-based central bankers. The general modus operandi was to deliver a stable platform for market-based economic activity by targeting the inflation rate and anchoring expectations of price movements. But what has happened since the GFC is that external developments more frequently and directly override domestic economic and political policy formulation.
Compounding the implications of this restructuring is the uncomfortable fact that there are widespread differences of opinion about the content and timing of prospective policy changes.
Central bankers have extended their powers and influence to an extent unimagined before the GFC. Ironically, their embrace of unconventional policies such as quantitative easing has undermined the reliability of their tools of trade; namely modelling the interplay of economic forces for the purpose of deriving a policy framework that would deliver the targeted inflation rate. Bond yields that reflect the views of the market occupy an important role in this process.
However, few if any economic models would have forecast the upheaval that has occurred in the yields on bonds issued by the governments of developed economies in recent months.
According to the RBA, about $US7.6 trillion, or almost one-quarter of developed markets' sovereign debt has recently traded with yields at or below zero. This includes almost half of Japanese sovereign debt and about two-thirds of German sovereign debt.
"While the magnitude of these falls in sovereign bond yields is," the bank says, "difficult to explain, the declines reflect developments in both supply and demand for such securities."
Read the full article here: It’s not polite to mention the currency war (subscription required)