Desperate times?

Central banks consider unusual measures - while credibility erodes from governments

The Federal Reserve announced today that it would operate a 'twist'.  It will sell short dated Treasury bonds and buy back long dated Treasury bonds.  This is in an attempt to flatten the US yield curve.  At the moment, the interest rates (or yields) on bonds of only a few years life are very low compared to longer dated bonds.  That means the yield curve, plotting yields against bond maturity dates, is steep.  The hope is that this operation, worth $400bn, will lower longer term interest rates and help kick start the economy eg through business investment.

It may be successful. It is certainly ususual. Much depends on overall confidence levels in the economy. You can have a situation where interest rates are very low but still businesses don't increase investment (driving growth).  That's the situation we have now. Demand levels in many economies are low.

In the UK, the minutes of the last MPC meeting published by the Bank of England today, indicate that the MPC believes further Quantitative Easing (creating money and buying assets eg bonds) is inevitable on top of the £200bn in the first round. That is, if conditions remain the same or worsen.

The impact of the eurozone and US debt crises over the summer is beginning to be felt in the economy it seems, with some indications that businesses are holding back on orders. Meanwhile, governments (and oppositions) around the world are facing their own credibility crises as increasingly investors doubt their resolve on debt and growth, and voters doubt their ability or willingness to act to improve their future prospects and living standards. In the UK, the austerity measures are increasingly under strain; pain with no gain is not a credible strategy. In such circumstances, political leaders worldwide need to take stock and see their way through the present turmoil by excercising political and market leadership.

Stephen Beer, 21/09/2011

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