Nomura economist Richard Koo is out with his first comments since Janet Yellen’s first FOMC meeting last week.
Remember, Yellen briefly spooked markets with what some perceived to be a hawkish tone, mostly owing to the specificity with which she talked about the timing of the first rate hike.
According to Koo, the US is in a “QE Trap” and both the market and the media are missing it. This trap, he says, explains the hawkish bent.
The argument is essentially that risks of very hot inflation are much higher now than they would be if we were coming out of a normal slump that didn’t require QE. But that because we did QE, and there are all these excess reserves in the system, the potential for very rapid loan growth and very hot inflation are now significant and thus the Fed has no choice but to be more hawkish than it otherwise would be at this stage in the recovery.
This is a contrarian stance that’s not in line with most thinking, but then Koo rarely is.
Markets and media unaware that US is in QE trap
Nevertheless, it was easy enough to predict that the Fed would have to move in this direction when it began normalizing policy after years of quantitative easing. The media’s criticism of her dialog with the market and market participants’ complaints about the lack of further accommodation tells us that most of them have yet to realise the US economy has fallen into the QE trap. Their ignorance is of far greater concern, in my view. Market participants and members of the media simply do not understand that an economic recovery in a country that has undertaken QE is going to be very different from a recovery in a country that has not.
Central banks much less tolerant of inflation after QE
What they need to understand is that a central bank that has engaged in QE is far less tolerant of inflation expectations than a bank that has not. The central bank that has conducted only orthodox monetary accommodation can sit back and watch as private loan demand picks up, driving an economic rebound. Rate hikes need to be considered and implemented — gradually — only after the economy approaches full employment and prices and wages have started to rise. In this case there is no reason for the central bank or the markets to fear an economic recovery — it can be welcomed with open arms.