Tuesday, October 16, 2012
Global angst should not dominate public policy - Carney
The boost to financial markets from extraordinary central bank liquidity may not continue if economic fundamentals do not ultimately improve, warned Mark Carney, governor of the Bank of Canada.
Investors should not be lulled into complacency by the low level of the VIX – a standard measure of market volatility – as a synchronous slowdown is under way in the global economy and financial markets could suddenly turn volatile.
“The dampening effect of central bank action may not persist if economic fundamentals do not ultimately improve, meaning that there could be a discontinuous shift in volatility at some point in the future,” Carney said in a speech in British Columbia on Oct. 15.
“Paralysis, not confidence, may better account for the observed declines in actual and implied volatility. This apparent lack of conviction in markets can itself be considered a sign of unusual levels of uncertainty,” he added.
But while there are real reasons for the deep sense of uncertainty and angst in financial markets, Carney said this should not dictate public policy and the world is in a much better place than 80 yeas ago when Franklin D. Roosevelt told Americans that “the only thing we have to fear is fear itself.”
“Nonetheless, the spirit of FDR’s comment applies―we must take care not to allow uncertainty to dominate our actions, letting profitable opportunities slip away and, more generally, compounding the very real, but still manageable, challenges facing the global economy,” Carney said.
In addition to his role as Bank of Canada governor, Carney is also chairman of the Financial Stability Board (FSB), a body that monitors and advises on global financial stability.
One of the triggers of uncertainty over the global economic outlook is the unfamiliar process in advanced economies of repairing public and private balance sheets. This process is hampering global growth and exposing the challenges facing policy makers, whether in the U.S. or Europe.
Concern over how these policy-makers will address these challenges triggers additional uncertainty, prompting firms and consumers to retrench, slowing growth further.
“Thus, the current combination of economic weakness and heightened uncertainty may be forming a vicious circle in the global economy,” Carney said.
While it is that clear uncertainty has real economic effects, the precise impact is not clear.
Researchers at Stanford have estimated that the rise in policy uncertainty between 2006 and 2011 reduced the level of real U.S. GDP by approximately 3 per cent and was associated with a loss of about 2.3 million jobs.
And at the Bank of Canada, researchers estimate that the increase in policy uncertainty observed since the re-intensification of the euro- area crisis late last year may have lowered the level of euro-area GDP by roughly 1 per cent, Carney said.
Among the steps policy makers in Europe can take to reduce uncertainty is tell citizens that solving the debt crises will take several reforms over a 3 to 5 year period, not just one single summit meeting.
“By reframing expectations to a realistic timeline, and ensuring that any financing assistance program for countries is sufficient for this period, European authorities could arrest the cycle of crisis summits, and thereby reduce policy uncertainty,” Carney said.
In the U.S., Carney said there is evidence that uncertainty surrounding the resolution of the so-called fiscal cliff is already having an adverse impact, pointing to a 26 percent drop in new orders for capital goods over the past three months, the area one would expect to see the greatest impact of uncertainty.
While he acknowledged the need to reduce public debt, he added that American households have recovered more than two-thirds of the $16 trillion in net worth lost in the financial crises, U.S. banks had increased capital and corporate balance sheets were strong.
But aggregate U.S. debt has not budged much from its peak of about 250 percent of Gross Domestic Product as the burden of deleveraging has been transferred from the private to the public sector.
The Bank of Canada assumes that the U.S. will step back from the fiscal cliff, bu there will still be some fiscal tightening that reduces growth and maintains the pressure for further debt reduction.
“A clear, consistent and committed medium-term U.S. fiscal plan, one that demonstrates how this consolidation will be achieved, would be helpful in mitigating a major uncertainty that would otherwise endure.