16 January 2019

Policy guidelines: The inconvenient truth

The housing policy failure of Hong Kong’s first post-colonial administration led by Tung Chee-hwa, who had set the annual supply at 85,000 units, has shown that when policymakers insist on certain rigid measures in the face of drastic changes in the economy or capital market, the situation could actually worsen. Now, a similar kind of challenge confronts central banks in the West with regard to interest rates, Hong Kong Economic Journal’s investor diary column noted on Monday.

The US Federal Reserve and the Bank of England have set their respective referencing rates on unemployment at 6.5 percent and 7 percent for any upward adjustment in interest rates.

Such guidance is intended to manage interest rate expectations and convey to the market a message that the interest rate levels will remain extremely low for some time.

Policymakers most probably have expected that it will take at least two years for the unemployment rates to fall to those target levels, implying that an interest rate hike won’t happen before 2015.

The thing is the unemployment rates of Britain and the United States are more dependent on the participation level in the labor market than on the actual pace of job creation, which could make the jobless rates fall faster than the timeframe the central banks have in mind. But the “improvement” would not truly reflect the overall picture in the job market. In the US, for instance, falling headline jobless rate has been accompanied by slow job creation.

Bank of England governor Mark Carney, the former chief of the Canadian central bank, had pledged to consider raising interest rates if the unemployment rate drops to 7 percent. Carney surely didn’t expect when he took office in July last year that the unemployment rate of the United Kingdom would shortly fall to 7.1 percent.

Facing the dilemma, Carney hinted to reporters at the World Economic Forum in Davos last month that the Bank of England will consider other indicators, such as the number of part-time workers, working hours and pay, to determine the real situation of the labor market, instead of solely relying on the country’s unemployment rate to set the interest rate policy.

Judging from the recent employment reports in the United States, the Fed is inevitably facing situations similar to the Bank of England.

They both underestimated the impact of the level of participation in the labor market on the unemployment rate, which unfortunately presented an illusion of better employment situation, causing backfire to the management of interest rate expectations.

Worth noting is that significant adjustments in equity prices in the United States throughout January and February are partly attributable to the volatility in emerging markets. However, the country’s poor employment data in December last year, and a sharply weaker Institute of Supply Management manufacturing index in January may also have contributed to the stock falls.

The US January employment report released last Friday showed new jobs have come at a pace that lagged way behind expectations for two consecutive months. The stock markets, however, rose for two consecutive days on Thursday and Friday, suggesting more investors are betting on a revision of even scrapping the Fed’s previous guidelines.

After his remarks in Davos on the central bank’s forward guidelines, Carney has greatly lost his credibility. Meanwhile, the Fed will be under the spotlight in the coming weeks as the market prepares for the Feb. 20 release of the minutes of the central bank’s last policy meeting.

How the pro-guideline Fed chair Janet Yellen and her deputy — former Israel Central Bank governor Stanley Fischer, who has openly said overly precise forward guidance will only add to market confusion and curb policy flexibility — will coordinate their efforts will be watched very closely.

– Contact the writer at [email protected]


Freelance journalist

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