Author Archives: Jesper

Lessons from the 1970s and monetary policy today

In my previous analysis (link) I contrasted the Bundesbank and the Fed during the high-inflation episodes of the 1970s. I concluded that the Bundesbank fared better: German inflation was lower and less volatile. Today’s situation resembles the situation in the 1970s. What can monetary policymakers today learn from events back then? A lot, I think. At the same time it also seems as if some important lessons have been forgotten.

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Lessons from the 1970s: Germany vs. U.S.

Today’s situation shares many similarities with the situation in the 1970s: Sky-high inflation, war, insufficient tightening of monetary policy, uncertainty about the economic outlook, and more. Countries responded differently to the events back then, though. I analyse the reactions of the German and U.S. central banks and emphasize lessons relevant for today. My next analysis will examine what current monetary policy can learn from those experiences.

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Yield spreads and recessions

The slope of the yield curve, or the yield spread, has consistently predicted recessions. Following a flattening of the yield curve–a rise in yields on short-dated government bonds relative to yields on long-dated government bonds–the economy often contracts. There are different yield spreads, though. Right now some indicate that we are heading for a recession while others imply low recession probabilities. Which ones should you rely upon and what are the implications? I analyse data from the US and Europe (Germany) and provide answers.

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ECB’s additional dilemma

In December I argued that inflation is too high but that the European Central Bank (ECB) faced a dilemma (link): Raise rates and high-debt countries will suffer, or keep rates low and inflation will remain too high. I concluded that the ECB should start raising rates. Inflation is now even higher, and the ECB faces an additional dilemma: Raise rates and risk derailing a recovery already suffering under the weight of elevated uncertainty and high energy prices, or keep rates low and inflation will remain too high for too long. Another worrying development is that ECB risks losing its grip on inflation expectations. What to do?

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Yield, growth, and valuation

Yield, growth, and valuation drive stock returns. Historically, in long-run US data, yield has been most important. This is no longer the case. Since the financial crisis, and in particular during the past couple of years, increasing valuations have been the main drivers of stock returns. Unless there are permanent bubbles in the stock market, valuations cannot continue to increase indefinitely but will eventually revert. Recent stock-market turmoil makes sense in this light.

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Three unusually good years in markets. Why and will it continue?

A few months ago, I argued that there is a real risk stock markets will suffer when central banks tighten monetary policy in response to high rates of inflation (link). This is what we are witnessing now. Stock markets have struggled since the turn of the year in response to monetary policy take-offs and rising rates. To understand why this is happening and where we come from, this blog analyses the performance of the stock market during the past couple of years. Stock returns have been unusually high, given subdued economic growth. How can we comprehend this apparent contradiction and what does it imply for the future?

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ECB’s dilemma: Choosing between the devil (raise rates) and the deep blue sea (don’t raise rates)

Inflation in the Eurozone is historically high. One would expect that the European Central Bank (the ECB) would only talk about raising rates. Instead, they only talk about keeping rates low, in contrast to other central banks. Why is the ECB so strongly ruling out even the possibility that rates might be raised? Probably because there are highly indebted countries in the Eurozone that would suffer. The ECB is caught in a dilemma: Raise rates and risk that Italy (and other countries) will face debt-servicing challenges or keep rates low and risk that inflation remains too high. What to do?

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Best in test: And the best stock return predictor is…….. end-of-the-year consumption growth

A new paper thoroughly examines the empirical performance of leading stock-return predictors. Most predictive variables perform poorly. One variable stands out as a consistent predictor, though: End-of-the-year consumption growth, a variable Stig V. Møller and I introduced in 2015. It feels a little like winning the “world cup in return prediction”.

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Frothy stock and housing markets: How worried should we be?

Historically, either stock markets or real estate markets have been frothy during periods of market exuberance. Today, according to usual metrics, both stock markets and real estate markets trade at historically elevated levels. I admit I am getting nervous. True, there are comforting factors. Most importantly, credit growth is low. Second, it is always difficult to predict when markets turn sour. I discuss arguments for and against looming real estate and stock market turbulence. I conclude that monetary policy fuels bubble-like behavior in asset prices, and that Quantitative Easing (QE) should stop. But what will happen then?

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