Professor Christina Romer (University of California, Berkeley) spoke at the National Bureau of Economic Research's (NBER) Annual Conference on Macroeconomics on April 12, 2013 about the BOJ’s new ultra-easy monetary policy, which was announced on April 4. Her speech was titled, “It Takes a Regime Shift: Recent Developments in Japanese Monetary Policy Through the Lens of the Great Depression.” She is all in:

The regime shift we are seeing in Japan is just the kind of bold action that might actually succeed in changing both inflation and growth expectations a substantial amount. As a result, it may be an effective tool for encouraging robust recovery and an end to deflation.

She claims that FDR’s similarly bold monetary regime shift “managed to turn our ocean liner of an economy on a dime.” She believes that the Fed has been too cautious since early 2010.

IMF Chief Christine Lagarde, the central banker of the central banks, welcomed the huge monetary stimulus plan unveiled by Japan. She said that Japan’s loose monetary policies and “unconventional measures” should boost global growth, and “the reforms just announced by the BOJ are another welcome step in this direction.”

The BOJ has announced its plan to double the monetary base of the country--adding $1.4 trillion--by the end of 2014 in an attempt to end the deflation plaguing the economy. The BOJ will do so mainly by buying more long-term government bonds raising the average remaining maturity of its holdings from about three years to seven years--keeping downward pressure on yields all along the curve.

Notice that no one is asking whether it makes sense to stop deflation. The BOJ’s theory, which is shared by Fed officials, is that a little bit of inflation is a good thing because it might stimulate demand as a result of buy-in-advance attitudes. Maybe so. More likely is that low inflation won’t have that impact, and it will certainly reduce the purchasing power of consumers.

Don’t worry, there will always be something to worry about. Yesterday, I reflected on how well the bull market has weathered numerous Apocalypse Now crises over the past four years. Many of them actually seem to be abating, forcing apocalyptic market pundits to postpone the predicted end of their endgame scenarios. Most recently, I anticipated that the Cyprus Moment wouldn’t turn into Europe’s Lehman Moment. Sure enough, the Cyprus problem was resolved over the weekend.

But it didn’t take very many moments yesterday for the initial rally in stock prices to be reversed by really stupid comments from a top European official. Jeroen Dijsselbloem, who heads the Eurogroup of euro zone finance ministers, told Reuters and the Financial Times that when failing banks need to be bailed out, euro zone officials would force the bank's shareholders, bondholders, and uninsured depositors to contribute to their recapitalization. He also said that Cyprus was a template for handling the region's other debt-challenged countries. Financial shares were among yesterday’s losers, especially in France and Italy.

Mr. Dijsselbloem, who is also the Dutch finance minister, said, “Taking away the risk from the financial sector and taking it on to the public shoulders is not the right approach.” That makes a great deal of sense, in theory. In practice, his reckless comments could easily upset the relative market calm that he said allowed his group to force private investors and depositors to pay for the bailout of two large Cypriot banks.

ECB President Mario Draghi deserves all of the credit for calming Europe’s markets with his pledge to do whatever it takes to defend the euro at the end of July last year. He did it again just yesterday when the ECB gave Cypriot banks access to its Emergency Liquidity Assistance (ELA) facility. By Monday afternoon, Dijsselbloem attempted to retract his earlier remarks as he issued a statement: “Macro-economic adjustment programmes are tailor-made to the situation of the country concerned and no models or templates are used.”

(Based on an excerpt from YRI Morning Briefing)

At his press conference today, Fed Chairman Ben Bernanke observed:

There has been a certain tendency for a spring slump that we have seen a few times. One possible explanation for that, besides some freaky things, some weather events and so on, one possible explanation is seasonality. Because of the severity of the recession in 2007 to 2009, the seasonals got distorted, and they may have led--and I say ‘may’ because the statistical experts, many of them, deny it--but it is possible they led job creation and GDP to be exaggerated to some extent earlier in the year. Our assessment is though, at this point, that we are far enough away from the recession that those seasonal factors ought to be pretty much washing out by now.

As Mr. Bernanke noted, many statistical experts deny that there has been a distortion at all. For example, two economists at the Bureau of Labor Statistics analyzed the problem in an article appearing in the October 2012 issue of Monthly Labor Review. After a careful and thorough analysis of the data, they concluded: “Removing the declines due to the 2007-2009 recession prior to seasonal adjustment in a number of experimental data series reveals that the recession did not create any bias causing a pattern of stronger increases in employment in the winter months of the fourth through the first quarter versus weaker increases from the second to the third quarter.”

Cyprus has been a safe haven for money-laundering operations. Russians have large deposits in the island's banking system. The tiny nation, which is one of the 17 members of the euro zone, has only 860,000 people, but the banks have €68.4 billion in deposits. The Germans are in no mood to bail out Russian depositors in Cyprus, which is why the initial bailout plan required a 9.9% wealth tax on large uninsured deposits. Small depositors were also hit with a levy.

Undoubtedly, the final deal will be amended to cushion the blow to small depositors. However, the latest mess in the Euro Mess is a reminder that Mario Draghi's pledge to do whatever it takes to defend the euro won't clean up the mess. The pledge bought time, which must not be wasted or the Euro Mess will last for years to come. The “Cyprus Moment” is yet another waste of time.

For now, the euro zone is falling deeper into recession, as evidenced by the region's weak production numbers during January (Fig. 1). The UK is heading in the same direction (Fig. 2). The question is how long will the Cyprus Moment last, and will it morph into Europe's Lehman Moment? I doubt it. So far, government bond yields for both Italy and Spain remain subdued (Fig. 3). I don't expect that TARGET2 payments will show outflows from these two debt-challenged nations to Germany as a safe haven (Fig. 4).

(Based on an excerpt from YRI Morning Briefing)

This past weekend, euro zone finance ministers agreed on a shocking bailout plan for Cyprus. It requires bank accounts with balances above €100,000 to be taxed at 9.9%, while those with less will be taxed at a 6.75%, to raise €5.8 billion for the near-bankrupt nation. This marks the first time in the euro zone crisis that depositors in the bloc's banks will lose money. This unprecedented move to make depositors contribute to a bailout is stoking fears of deposit runs hitting all fragile euro zone banks.

I don’t expect this “Cyprus Moment” will turn into a Lehman Moment for the euro zone. However, the plan could shatter the calm in the euro zone following the pledge at the end of last July by ECB President Mario Draghi to do whatever it takes to defend the euro. The only upside is that we won’t have to worry about irrational exuberance until this latest mess in the Euro Mess is cleaned up.

(Based on an excerpt from YRI Morning Briefing)

Japan’s new Prime Minister Shinzo Abe has chosen Haruhiko Kuroda to be the next governor of the Bank of Japan (BOJ). Once he is approved by the Diet, the new governor is expected to push for unlimited QE to start immediately rather than in 2014. The goal is to reflate the economy with a target of 2% for the inflation rate (Fig. 1). The BOJ’s Policy Board is scheduled to hold its first meeting under the new leadership on April 3 and 4.

The question is: Will Abe’s new fiscal and monetary stimulus programs be any different than the same old tired Kabuki of the past two decades? The fact is that we’ve seen this play several times before with the same unhappy ending. Numerous Japanese governments have resorted to such measures to boost growth rather than implement much-needed economic reforms. Nominal GDP has been virtually flat (up only 0.6%) since Q1-2009, with real GDP up 7.3% (over the entire period!) and the GDP deflator down 6.7% (Fig. 2). The Nikkei is up 34% since November 13, 2012, and the yen is down 15.2% over the same period (Fig. 3 and Fig. 4). However, swings of this magnitude have occurred in the past since 1990 without any significant improvement in the performance of the economy.

(Based on an excerpt from YRI Morning Briefing)

The minutes of the January 29-30 FOMC meeting were released today. If the economy improves, then more members of the committee are likely to push for ending or phasing out quantitative easing. If the economy remains weak, then the Fed is likely to continue purchasing $85 billion per month in Treasuries and mortgage-backed securities (Fig. 1 and Fig. 2). So what should we be rooting for?

If economic growth remains lackluster, there will be mounting concerns that the Fed’s ultra-easy monetary policy is losing its punch and that providing more of it won’t help. Self-sustaining economic growth should be bullish for equities. However, the market has become addicted to injections of QE (Fig. 3). If they are withdrawn too rapidly, the market might go through withdrawal. The internal debate at the Fed about phasing out QE already seems to be unnerving investors. If the pace of economic activity does pick up, the worry will be that inflationary expectations will rise, forcing the Fed to reverse course. That would push bond yields higher, which could put the brakes on any housing-led economic boost (Fig. 4).

The latest minutes reported: “Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound….” Furthermore, “a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability.” In other words, rising stock prices and falling yields on junk bonds suggest that the Fed might be pumping air into asset bubbles again.

According to the latest FOMC minutes, Esther George, president of the Kansas City FRB, was the sole dissenter, voting against continuing QE because of her concern about “the risks of future economic and financial imbalances.” She explained her views in a 1/10 speech that I previously reviewed. I also previously reviewed a 2/7 speech by Fed Governor Jeremy Stein in which he warned that some credit markets are showing signs of potentially excessive risk-taking.

On Friday February 22, Bloomberg reported that Fed Chairman Ben Bernanke “minimized concerns that the central bank’s easy monetary policy has spawned economically-risky asset bubbles in comments at a meeting with dealers and investors this month….” On January 14 at the University of Michigan’s Gerald R. Ford School of Public Policy, he said:

There’s a lot of disagreement about what role monetary policy plays in creating asset bubbles. It is not a settled issue. Our attitude is that we need to be open-minded about it and to pay close attention to what’s happening. And to the extent that we can identify problems, you know we need to address that.

He concluded that the “first line of defense” if bubbles emerge “needs to be regulatory and supervisory” actions rather than changes in monetary policy.

If all this is starting to make your head spin, you are not alone. In my opinion, the Fed won’t waver from its current course of ultra-easy monetary policy until Ben Bernanke’s term as Fed Chairman expires on January 31, 2014. If he isn’t reappointed or if he retires, odds are that either Janet Yellen or William Dudley will replace him. This troika has led the super doves on the FOMC. The latest minutes undoubtedly reflected their collective view as follows:

A few participants noted examples of past instances in which policymakers had prematurely removed accommodation, with adverse effects on economic growth, employment, and price stability; they also stressed the importance of communicating the Committee’s commitment to maintaining a highly accommodative stance of policy as long as warranted by economic conditions. In this regard, a number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer period than envisioned in the Committee’s exit principles, either as a supplement to, or a replacement for, asset purchases.

(Based on an excerpt from YRI Morning Briefing)

In a speech today, Fed Governor Jeremy Stein, a voting member of the FOMC, examines “the dynamics of overheating episodes in the credit market.” He focuses mostly on the junk bond market as a useful barometer of financial excesses. Only an economist can say the following: “Thus, overheating in the junk bond market might not be a major systemic concern in and of itself, but it might indicate that similar overheating forces were at play in other parts of credit markets, out of our range of vision.” He concludes: “One of the most difficult jobs that central banks face is in dealing with episodes of credit market overheating that pose a potential threat to financial stability.”