Sunday, January 15, 2012
Tight fiscal/ loose money - policy mix of the year
There are certain policy mixes that dominate in any given period. Most countries are following the same combination, loose monetary policy and tight fiscal policy. This is especially true of developed countries. The result of easy monetary policy is that real rates are being taken to negative levels in an effort to reduce or eliminate the fiscal drag from tight government spending policies. Additionally, the loose monetary policy offsets the large budget deficit problems as negative real rates reduce the cost of budget deficits. This places a negative bias to currencies relative to those countries which follow a different mix and a positive bias toward commodity prices. Bonds will do well as rates are pushed to further negative levels. Equities will be mixed because of the offsetting policies in fiscal and monetary policy. Of course, this a dangerous policy mix because there is potential for higher inflation when economies improve or fiscal policy becomes looser.
The US is following a relatively loose monetary policy which is on the cusp of having another round of quantitative easing. The fiscal side is tightening even with large budget deficits because the stimulus of 2009 has run out. The Euro-zone clearly has a tight fiscal environment to stem the tide of debt downgrades and large budget deficits. The ECB is engaged in a non-announced QE program with strong lending facilities for banks. This will be further loosened if they announce a program of QE. The UK has continued to follow its tight fiscal/loose monetary combination. Japan has tightened ineffective fiscal policy with the monetary policy that should follow further easing. The emerging markets are starting to loosen and have not generally followed easing fiscal policy.
The net result may be slower growth with ambiguous currency markets. Currencies will not able to provide the boost expected if all countries are following the same mix.