Thread by @VMRConstancio

Amid the Trump shenanigans of last week, the relevant speech by the FED Chairman J. Powell was perhaps not much noticed. He clarified some aspects of the new monetary framework (that so far didn´t trigger any new measures) and made a very strong appeal for more fiscal stimulus /1

“The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery..By contrast, the risks of overdoing it, seem..to be smaller”/2 federalreserve.gov/newsevents/spe…

Basically, he implied that monetary policy is practically done:“ The Committee also left the target range for the federal funds rate unchanged . and it expects .. to maintain this target range.”. So, the additional effort has to be fiscal. The same approach applies to Europe. /3

Unfortunately, despite the deceleration of demand recovery, the crucial European Recovery Fund will start disbursements next second half and according to the ECB will disburse only 10% of the total in 2021, hopefully allowing national budgets to do more /4

Besides the recovery needs, negative news on euro area inflation justify stimulus policy. Headline level at -0.3 in September you (but following a -0.2 In August) and core inflation at only 0.2 (0.4 in Aug.). Oil prices and VAT German reduction help to explain this evolution /5

CBs cannot fine-tune inflation at a monthly or quarterly level (judging by the last 12 years, not even at a few years level). Inflation for long periods of time depends on several different variables, meaning that it´s not always just a domestic monetary phenomenon. 6/

Still, markets and even CBs seem to follow the Friedman mantra that they can control inflation at will. This idea is now outmoded. Sometimes, it doesn´t pay “pushing on a string.” Oil price, VAT changes, and supply-driven shocks cannot be overcome in the short run by Mon Pol 7/

On the other hand, interest rates in the credit and securities markets are already quite low. Deeper negative policy rates would add collateral damage to financial stability. 10Y bonds for Gr., Ita. are below 1%; Sp, 0.16,Port. 0.17 both up to 7Y with negative yields; DE -0.5 8/

What stimulus from bringing all those rates further down? The euro exchange rate, after1.2 vs the USD, stabilized around 1.17, its level at inception. The effective fx rate increased this year but mostly offsetting the undervaluation at Dec 19 (see IMF)9/ imf.org/~/media/Files/…

Therefore, overall financial conditions are quite expansionary. On top of this, there isn´t much that can (or should) be done regarding the exchange rate, now that the dollar apparently started one of its waves of depreciation. There are several drivers behind this.. 10/

One driver is the return of the US twin deficits (see Bloomberg´s @john_authers chart). Another driver is the FED new monetary framework that implies low-interest rates for longer until inflation will stay a few years above 2% to offset previous underperformance 11/

Especially in the US, what started as a necessary and temporary monetary policy answer to financial markets collapse, became a sort of “policy put” and “financial dominance”, with a continuing weak real economy reaction to low rates and favourable financial conditions 12/12