Generational Differences - Rise of the Socialists

Young people have a different view on the world than older generations who have made the most from capitalism

Youth is the one thing that most people would want – a chance to live it all over again – but it is not an easy time to be young at the moment.  Young people are facing the toughest job market in decades after having gone through an education system which has been neglected for years with more money being spent on pensions instead.  So it may not be surprising that youngsters are not as keen on capitalism as older generations.  And this is not just part of a rebellious phase but rather a response to an economic system which is geared to benefit long-time members to the detriment of new-comers. 

To start with, let’s look at the job market.  Unemployment rates remain stubbornly high in most countries with developed economies but the proportion of young people without jobs is typically substantially higher.  For example, more than half of younger workers in Spain and Greece are unable to find work.  Joblessness not only has temporary effects such as a loss of income but studies have shown that youngsters who enter the market when the economy is sluggish often earn less over their lifetimes.  The current situation for young people goes beyond this to talk of a “lost generation” who may become disillusioned with the job market and remain disengaged even when employment prospects improve.

This situation is made worse by a system fronted by labour unions geared to protecting the jobs of existing workers who come from an older generation.  This trend has been most damaging in Europe where the efforts of unions have resulted in a two-tier labour market.  Older workers have secured themselves stable jobs due to rules resulting in high redundancy costs whereas younger workers are typically employed on short-term contracts which are first to be terminated when job cuts are needed.  The rise of globalization also means that new-comers to the workforce are competing for jobs with workers in China and India as well as people in their hometown. 

This increased competition for jobs along with automation of work using computers and other new technologies has taken away many of the administration jobs that were the mainstay of work for the older generation.  Better paying jobs are increasingly limited to jobs requiring higher levels of education but this too is an area where young people have been short-changed.  Education is faced with spending cuts and students are being asked to bear a substantial portion of the costs as countries deal with high levels of debt as well as demands from older workers for lower taxes.  The irony of this situation is that spending on pensions and medical bills for the elderly is on the rise at the same time as education is suffering from cutbacks – societies are spending money on the old rather than investing in a new generation.

The housing market provides further evidence of the different fortunes of the older and younger generations.  Trying to get onto the property ladder is only getting tougher for first-time buyers whereas existing owners of property are benefitting from higher prices.  House prices have been surging in some places despite the economic doom and gloom as governments in many countries have even been bringing in measures to push up prices for real estate as a means to revive economic growth (which is why a rebound in UK house prices is not all good news).

With lower pay in less stable jobs (or unemployment) awaiting many youngsters, they are likely to be the first generation in a long time that will end up worse off than their parents.  The older generation must take part of the blame with many elements of the economy set up for their benefit – a seemingly obvious outcome in a world defined through competition where everyone from companies to political parties are battling it out.  The spoils from winning in this competitive environment are on the wane in wealthier countries as global economic rebalancing shifts more wealth to China and other countries on the rise (which is part of A New Inconvenient Truth).

Youngsters have experienced the harsher side of a market economy and it is no surprise that they see the current system as not working in their favour.  Surveys show a growing distrust of capitalism and increasing support for social spending among young people.  The disillusionment of young people has also extended to politics so it is later generations which vote and give direction to the policies of government.  But it seems obvious that changes beckon as the younger generation with their different experiences and views on the world take over the levers of power.  Marketing experts have been quick to jump on changes in habits of different age groups such as Generation X or Y.  Politics may see similar changes coming with the rise of a new generation – it will be interesting to see what world they will build for themselves.

Debt Ceiling: Once more unto the breach

Politics in the United States is starting to cause more problems than it solves as compromise still seems far off.

Politicians are not usually seen in the best light.  Even in that context, the partial shutdown of the federal government in the United States is exasperating, so much so that Your Neighbourhood Economist was not even going to bother to comment.  The situation leading to the shutdown brings to mind kids in a playground fighting over a toy with everyone losing out after all of the toys are put away.  However, behind all the antics and posturing, there are bigger themes at play which is even more depressing.

October is marked with a number of dates which gradually ramp up the economic stakes.  The month began with the US government having failed to pass legislation for its spending budget for the 2014 fiscal year which starts on 1^st October.  While the bulk of spending by the government, such as benefits for the elderly or unemployed, is not affected, a significant portion of money doled out by the government must first be ratified by Congress before being spent.  As a result, not passing the budget resulted in a partial shutdown of the federal government with around 800,000 out of 2.8 million public employees being sent home without pay.  The parts of government affected include bodies such as the Environmental Protection Agency and the Food and Drug Administration, meaning that many procedures such as permits for certain business activities will not be processed.  NASA will also mostly shutdown as will many of the tourist sites overseen by Federal government employees.

But the partial government shutdown is just a precursor to something more threatening – the government running out of money to pay its bills.  While such an outcome may sound preposterous, it stems from the current budget deficit (with the government spending more than it receives) and the need to borrow to make up the shortfall.  The total amount of debt that the US government can take on is also something that requires approval from Congress.  With the government having racked up a string of budget deficits in the aftermath of the global financial crisis, the amount of borrowing has been steadily rising.  More debt is needed but the government has reached the debt ceiling which was raised in 2011 and is expected to run out of money by around 17^th October.

The stakes are higher if no deal can be done with regard to the debt ceiling.  While the partial shutdown of government can be seen as a bit of a nuisance, a government cash shortage could have global ramifications if it means that the government misses an interest payment on its bonds and thereby triggers a default.  Given that US government bonds are akin to another form of currency in the financial system, a default has the potential to bring the global financial system to its knees. 

In spite of this, the financial markets, while on edge, have not panicked - negotiations regarding the raising of the debt ceiling are still on-going, and even if a deal cannot be brokered, the effects are still unclear.  There are other sources of income such as money from taxes so the government will be able to keep up with some outgoing payments.  But that in itself creates another dilemma – which, if any, payments to forgo.  Investors would hope that debt payment would take priority over, for example, the payment of pensions.  Despite the potential consequences to the international financial system, it would take a brave politician to cut off pensions for old people.

Considering what is at stake, the consensus view is that the politicians will sort themselves out before the government is forced into making such choices.  Your Neighbourhood Economist would like to assume that this will be the case.  But the two main political parties have been squabbling for number of years with the situation getting worse rather than showing any signs of improvement.  Over the past few years, there have been skirmishes over a previous increase of the debt ceiling in 2011 as well as the negotiations regarding the fiscal cliff less than 12 months ago (for more on this, see Winning the election was the easy part) and one of the key obstacles to compromise is growing in strength – that being the so-called Tea Party portion of the Republican Party.

The Tea Party is the radical anti-government element of the Republican Party which is not afraid to be aggressive in pushing for a reduction in the size of government among other policies.  Its members in Congress are targeting large concessions from Obama to raise the debt ceiling – a position which is further fortified by Obama having conceded little in previous showdowns.  Perhaps the biggest concern is that the anti-government fervour of the Tea Party will translate into a view that the debt ceiling is an effective way of slashing government spending irrespective of the costs involved.

The Tea Party has found growing support among Americans disillusioned with the role of the government.  It is part of the rise of populist movements that can also be seen in Europe which rail against mainstream policies, such as an opposition to immigration.  The multi-party political systems in Europe can include such movements as separate parties which often struggle to get the necessary level of support to make it into government.  The political system in the United States only has two political parties and the Tea Party essentially controls a large portion of the Republican Party.  With voting districts in the United States having been shaped over the years to produce safe seats for either the Republicans or the Democrats, Tea Party candidates in Republican seats are typically better at whipping up support enabling them to win out over more moderate candidates. 

The Republican Party as a whole has increasingly felt the need to pander to this radical fringe which has brought a heightened level of conflict to US politics, within the Republican Party itself as well as between the two major parties.  Its unique system of democracy has been a key element behind the successful rise of the United States to global dominance.  But with the country’s place at the top of the global pecking order no longer assured (as described in A New Inconvenient Truth), it would be ironic if its political system was central to its downfall.

Eurozone crisis: Still bubbling away

The debt crisis in Europe seems a long time ago but a political hiccup in Italy shows that its revival may not be that far off.

Around this time last year, weeks would go by without this blog commenting on anything but the Eurozone crisis.  The turning point came near the end of 2012 with a bit of imaginative policy making by the European Central Banks who said they were willing to do “whatever it takes” to save the euro.  By the start of 2013, the worst seemed to be over (Good and Bad in 2013), but many of the problems still had to be fixed.  This year has seen the economic problems in Europe simmering away in the background rather than being likely to erupt as in 2012.  However, the turmoil in Italy at the moment shows that it does not take much for things to heat up again.  Europe may not dominate the headlines as in the recent past but it is never too far from the front pages and here is a look into why.

Politics in Italy are tricky at the best of times but an election earlier this year left the country with a fragile coalition.  A fresh saga was triggered as the constant distraction that is Silvio Berlusconi looked to pull his support from the government after being convicted of tax fraud in August.  Yet it was Berlusconi who suffered from his latest attempt at meddling as he was forced into a dramatic U-turn which involved providing support to the government in order to avoid seeing his own party rebel against him.  After a jump in the interest rate on Italian government bonds, the weakening of Berlusconi cheered investors as he had held sway over Italian politics for a long time despite Italy having not benefited much from his time in power.

Although Italy has avoided the unwelcome prospect of another round of elections, the problems that the country faces are greater than the immediate political woes (for some background, see Bigger than Berlusconi).  This year, the government budget deficit is expected to top 3%, which is the upper limit for EU countries, with government debt approaching 130% of GDP.  The coalition government lacks the political capital to push through the necessary reforms to get the economy moving ahead to help generate the tax revenues needed to reduce the shortfall in the government’s finances.

Italy is hampered by a problem which is typical for countries in Europe feeling the strain in the aftermath of the Eurozone crisis – voters weary of austerity measures with little to show for their perseverance.  Mainstream political parties who have been pushing government cuts have seen their support eroded by fringe parties which promise relief through policies which will have negative long term effects.  The democratic process has struggled to deal with the consequences of the economic slump and mounting debts following the global financial crisis.  Voters have been stuck with two unappetizing options – enduring the hardship of austerity with scant rewards or repelling against spending restrictions but becoming an outcast in the financial system.

The same themes can be seen being played out in Portugal and Greece among others.  Greece has witnessed the rise of the far-right extremist Golden Dawn party which has fed off the frustration of Greek voters.  Local elections in Portugal resulted in heavy losses for the ruling party who had pushed through austerity measures.  Despite all the hardship endured in these two countries, further bailouts are seen as necessary to deal with the stubbornly high levels of government debt.  The economic stagnation in Europe continues with countries like Greece still suffering with GDP down by 6.4% in 2013.  Portugal, Italy, and Spain among others also ended 2012 with lower GDP. 

While the European Central Bank has staved off the immediate threat of crisis, the flipside is that the pressure for reforms has eased.  As such, politicians can no longer blame the financial markets for their unpopular policies.  Leadership in Europe has also been lacking with the national elections in Germany drawing the attention of Angela Merkel away from Europe.  Coalition negotiations in Germany following the elections in September will leave Europe seemingly leaderless for a few more months.  The Eurozone crisis may have been put on the back burner but it could still boil over at any point if not watched.

Inflation – Then and Now

Inflation is driven by different factors now that the West is no longer the only engine of growth in the global economy but why might that be important?

Life is always better as the top dog, whether it be on the playground or at work. The same holds true for the global economy where large and growing countries have others banging on their door to offer whatever they might need.  As a result, the global economy shapes itself around the countries at the top of the pecking order and these countries benefit as a result.  One seemingly innocuous way this plays out is through inflation.  Inflation in Europe and the United States has always moved in tune with their economies due to there being no other significant sources of demand.  But the switch to a global economy with other major players has resulted in international commodity prices being driven by what is going on in other countries as well.  This means that inflation is not what it used to be.  And, if inflation is different, must monetary policy change as well?

Inflation is the economic phenomenon of increases in prices, where prices will rise if demand increases at a faster rate than supply.  Due to globalization, many goods are now traded on international markets and growth in the global economy will push up demand (and the price) for any goods.  While demand can fluctuate dramatically in a short period of time, changes in supply typically take time.  Prices which rise due to expanding demand as an economy grows may remain high as increases in production require more time to catch up.  This is not so much of a problem when an economy is growing as consumers will have more money in their pockets and won’t be as bothered by higher prices.  Thus, it is easier to accommodate prices rising at a faster rate when the economy is prospering. 

In the past, the main source of demand for most products came from Western economies (Europe and the United States) along with Japan, with inflation moving in line with economic growth in these countries.  The level of synchronisation between these economies was also high so that growth spurts came at the same time and inflation was typically timed to when the economy was ready for it.  But this all depended on there being no other big economies which were out of sync with the West.

However, the economic rise of China and emerging markets put paid to this convenient form of inflation.  The number of factors which determined global commodity prices had increased and the economy in China was large enough to move to its own rhythms.  China’s entry into the global economy was initially a boost for Europe and the United States in some ways with low-cost manufacturing helping to bring down prices at the beginning of the century.  Yet, economic growth in China did not slow with the onset of the global financial crisis and prices for many global commodities kept climbing higher as a result.

High inflation is never good but it is even worse when an economy is struggling to climb out of recession.  Rising prices during slow economic growth further depress spending and put pressure on profits at companies when times are already tough.  Being an open economy with few of its own resources, the United Kingdom has had to suffer through both a stagnating economy and high inflation.  For example, real GDP in the UK edged up just 0.8% in 2011 while inflation reached as high as 5.2% in September.  Yet, the Bank of England did not change its monetary policy to quell inflation in 2011 as it was clear that the origin of the inflation was overseas. 

However, the situation may not always be so clear cut.  And it is not the first time that inflation has been out of whack with what is going on in the economy.  Interest rates were kept down in the lead up to the global financial crisis as inflation was weak due to cheap goods coming in from China.  The lower borrowing costs spurred on the lending binge which accentuated the crisis.  Inflation was picked out as a gauge which reflects the strength of an economy but it is questionable whether that is still the case. 

Europe and the United States are already struggling to deal with the rise of new challengers (for more on this, refer to A New Inconvenient Truth) as well as the aftermath of the global financial crisis (see economy still stuck in a rut for more).  Shaping monetary policy around something which is influenced by external factors is not going to be helpful in steering clear of trouble.  And, inflation in itself is not enough of a negative for the economy to be managed for its own sake (go to time to rethink inflation?).  Monetary policy should instead look at other measures of economic health such as unemployment which is obviously something that needs to be lower (to a certain degree). 

A more relevant basis for monetary policy would help bring much-needed clarity with regard to the direction of monetary policy as we wait for the Federal Reserve to start the long process of ending its quantitative easing policy.  Central banks have a lot to answer for in terms of their role in the lead up to the global financial crisis and improving the way in which the economy is managed would go a long way toward making amends.

Quantitative Easing - Harder to End than to Start

The Federal Reserve changes tack on its change of tack in monetary policy which will make it less credible in the future.

It is still a month away from Halloween but something seems to be scared Ben Bernanke, the chairman of the Federal Reserve.  Bernanke was expected to announce that the Federal Reserve would be buying fewer bonds in September but surprised most pundits (including Your Neighbourhood Economist) by deciding not to make any changes with the status quo.  The unexpected bonus of a delay to the start of “tapering” helped push stocks in the United States to record highs but gains were limited by worries about the future direction of monetary policy.  By backing down from a change in policy, the Federal Reserve has made its job of finding an exit from quantitative easing more difficult while also making it trickier for investors to understand the big question that still remains – how far off is the beginning of the end for quantitative easing?

The Federal Reserve began to signal a change in direction in May and June using its own version of forward guidance where central banks outline future policy through using economic data as markers.  The current policy of the Federal Reserves has entailed buying US$85 billion in bonds each month with interest rates set at close to zero – its forward guidance in July put forward an end to bond buying by the time unemployment reached 7% with interest rates to rise once unemployment had fallen to 6.5%.  With unemployment expected to reach its first target by the middle of 2014, there was an anticipation that the Federal Reserve would move to reduce its bond purchases before the end of 2013, so as to ensure a more gradual decline in quantitative easing which would be less painful for the economy. 

Yet, investors drew their own conclusions from the forward guidance and took it as an excuse to sell bonds whose prices had climbed to record highs (for more, see Managing Expectations).  As lower bond prices translates to higher interest rates for bonds, the bond sell-off resulted in interest rates on benchmark US government bonds increasing from around 2% to close to 3%.  This ran contrary to the gradual adjustment which the Federal Reserve was attempting to facilitate to ensure that the nascent economic recovery would not be choked off by higher interest rates. 

The jumpy market reaction along with slower improvements in the US job market were enough to spook the Federal Reserve into keeping the quantitative easing going.  Only time will tell whether the cautious approach was the right call but Your Neighbourhood Economist fears that Ben Bernanke may have been too timid for his own good.  While there is always the possibility of gremlins lurking in the economy somewhere, the timing did seem as good as it will ever be for starting the drawn-out process of tightening monetary policy.

Unemployment in the United States has fallen to 7.3% in August compared to 7.9% in January (even though part of the fall is due to some people not bothering to look for work any more).  And, while the size of the market reaction was a tad overdone, investors always factor in events ahead of time – as such, the bond sell-off was just the normal response to an end to actions by the Federal Reserve which have propped up both the markets for bonds and stocks.  So, any further movements in the financial markets were likely to have been muted.  But as it happens, prices for bonds and stock perked up as investors looked forward to continued efforts by the central bank to prop up the markets.

With the Federal Reserve forgoing an opportunity to pare back its bond purchases in September, market participants are trying to figure out the possible timing for the inevitable change in policy.  The Federal Reserve meets again in October but will have few new bits of economic data to sooth its concerns over the strength of the economy.  The subsequent meeting of the Federal Reserve is in December with this seen by many as the next chance for action. 

The cautious approach by the Federal Reserve does have its costs.  It is a fad among central banks these days to signal in advance of changes to policy, but by choosing not to follow through with the expected change of policy in September, investors will be less likely to believe the Federal Reserve in future.  In the short-term, it is unclear what will be sufficient to trigger the beginning of the end of quantitative easing – weak economic data for the rest of 2013 may see the “to taper or not to taper” saga drag on for a while yet.  The resulting uncertainty and likely volatility in the financial markets may be even more harmful than the expected tightening of monetary policy. 

A central bank is only as good as its word and the Federal Reserve has cheapened its own words.  That is a scary prospect considering the current hands-on management of the economy by the Federal Reserve and how much it will have to do to talk its way out of this management role.

Beware of a Flood of Funds

Surplus cash in the global financial system has a history of leaving havoc in its wake and quantitative easing may be making the situation worse.

There is a lot of cash sloshing around the international financial system at the moment.  Central banks are still buying heaps of bonds and there are few places in the actual economy where people are willing to invest money.  Not having cash around in the financial system can make life very difficult as shown by the credit crunch where lending by banks ground to a halt and the global economy came close to collapse.  But too much cash in the financial system can cause its own troubles.  Cheap credit is one of the causes of the global financial crisis.  More recently, emerging markets have been tested by the coming and going of a massive tide of global funds.  What can be done to ensure that more of the world is not drowned in an excess of cash?

It may seem strange but there is a lot of spare cash around at the moment but no one wants to use it.  Companies are hoarding money as business people are not confident in being able to make money through new investments, and consumers are paying off debt while being worried if their jobs are safe.  Adding to this, banks are reluctant to lend as new regulations are prompting banks to be more cautious about the amount of loans on their books. 

Central banks have tried to alleviate this problem by making it cheaper to borrow, firstly, through reducing interest rates to close to zero, and when this has not worked, printing more money with which to buy bonds.  The bond purchases also serve to further lower borrowing costs, but businesses and consumers currently seem averse to taking out fresh loans no matter how cheap it is to borrow.  Nevertheless, the bond buying continues with the Federal Reserve alone buying US$85 billion in bonds each month.  The extra cash is not going into the actual economy as there is no demand for it and it is free to be moved to anywhere in the world.

So this money is not like a still pool of cash where money can be drawn as necessary, but rather more like a tidal system where funds will flow in one direction for a certain period of time before switching to another direction depending on the alignment of economic factors.  Any free funds will always move in search of higher returns and the flows shift as economic circumstances change.  The transient nature of the funds creates economic problems due to the temporary effect of lowering interest rates and creating a surge in lending, only for the money to flow out again at the first signs of trouble.  These flows of cash now dominate the world economy like never before and can leave havoc in their wake (for more, see Where is all the money going?).  

This ebb and flow of funds is given as one of the reasons behind the global financial crisis.  The size of the pool of cash had swelled due to a glut of savings in Asia which were invested in the United States.  The resulting lower borrowing costs spurred on excessive lending which extended to sub-prime loans, eventually causing the near collapse of the financial system.  Almost the reverse has been the case in previous weeks.  Extra cash generated by the bond purchases by the Federal Reserves and other central banks had found refuge in emerging markets which had continued to grow in the aftermath of the global financial crisis.  But the tide turned with the paring back of quantitative easing in the United States, which is expected to result in higher returns from investments in the US markets. 

The worst of the effects have been experienced by India, Turkey, and Indonesia who had grown more reliant on the money coming in from overseas due to imbalances in their own economy.  But emerging markets have shored up their defences after having often been caught up in the wash of global finances.  Countries with developing economies often build up large foreign exchange reserves which are used to counteract the outflow of funds (which was ironically behind the glut in savings in Asia seen as responsible for the global financial crisis).  The use of controls which restrict the movement of funds have also become commonplace and are even somewhat sanctioned by the IMF (who are typically ideologically opposed to any limits on the free movement of resources).  Even the new range of banking regulations in the United States and elsewhere, such as rules on higher levels of capital buffers, can be seen as a buttress against the swirling forces of global finances.

However, the new measures being adopted in developed countries and in emerging markets have the goal of merely preventing the symptoms of the problems created by the surplus funds.  Furthermore, foreign exchange reserves and capital buffers come with their own costs – this money could be put to better use when the economy actually needs the extra funds.  Would it not be better to deal with the problem itself?  Central banks could come up with a way of soaking up the surplus money in the world’s financial system.  Considering the global scale of financing, this might require a new role for an international organisation such as the IMF.  It would also involve a rethink of quantitative easing and the tools available to central banks since the freshly printed cash from central banks has added another deluge of funds and has created problems of its own (see Perils of doing too much for more detail).  It would be a sad day for economists if the aggressive policies from central banks to revive the economy from the latest crisis sow the seeds of greater instability in the future.  

Managing expectations as part of monetary policy

In trying to ease concerns about higher interest rates through forward guidance, central banks have ended up doing the opposite.

Managing expectations when you work with people in an office environment can be tough but imagine dealing with the multitude of global investors as well as the international press.  This is what central banks have to cope with.  Central banks have tried to provide greater clarity regarding the direction of monetary policy using forward guidance – linking changes in policy to improvements in economic data.  The plan was to ease concerns that monetary policy would be tightened too soon through fewer bond purchases and eventually higher interest rates.  But forward guidance instead triggered the selling of government bonds with investors now expecting tightening of monetary policy sooner than central banks are suggesting.  Why have investors reacted in this way and what might central banks do in return?

A change in monetary policy was always going to be a tricky proposition considering the influence that the central banks have built up over the markets due to their purchases of billions in bonds as part of quantitative easing (refer to Caution - Windy Road Ahead).  It all started with a statement by the Federal Reserve in the US in June that it was considering tapering off its bond purchases which currently amount to US$85 billion.  Any new policy initiatives in the US are predicated on the pledge by the Federal Reserve that interest rates will remain at their current low levels until there is substantial improvement in the labour market.  This is one version of forward guidance that has also been adapted by Mark Carney, the new governor of the Bank of England, who also linked future decisions on monetary policy to the unemployment rate in the UK (for more, see Same low interest rates but for longer).  The reasoning behind forward guidance is twofold – to assure potential borrowers that interest rates will stay low for a few years yet and to placate fears that tightening of monetary policy will hurt the nascent economic recovery.

Not much of a market reaction was expected from these announcements as central banks were signalling that changes to the status quo would be gradual depending on the state of the economy.  However, investors have reacted in a way that seems to suggest that tightening of monetary policy is imminent, that is, by selling off government bonds.  The interest rates on government bonds have risen from record lows and 10-year bonds issued by the US and UK governments have both reached close to 3% (lower bond prices due to selling results in higher interest rates on bonds).  Why did the markets respond in this way to seemingly innocuous comments?

Cautious investors had been big buyers of safe assets such as UK and US government bonds due to the weak state of the global economy coupled with the sovereign debt problems in Europe.  This had capped off a period where bond prices had followed an upward trend for a few decades, which is a long time in investment markets.  Higher bond prices had pushed interest rates to painfully low levels so the timing was ripe for investors to move their money somewhere else.  All that was needed was a trigger and this ended up being the statements on forward guidance.  It is as if the mere mention of the end of the current loose monetary policy got investors thinking that a bond sell-off was coming and that it would be better to beat the rush.

For holders of UK government bonds, data on the economy has added to the reasons to sell.  The OECD released economic forecasts in early September which predicted that the recovery in the UK would pick up pace faster than in other countries.  A potential housing bubble in the UK adds to concerns that the Bank of England will have to increase interest rates earlier than planned.  Mark Carney also left plenty of escape clauses in the forward guidance pledges which allows the central bank the freedom to act but gives rise to worries that interest rates will not stay low for as long as has been suggested.

The rebellion of the markets against the careful planning of the central banks does throw up a few issues.  Considering that both the US and UK have mountains of government debt, higher interest rates will translate through to greater limitations on government spending which, in turn, will hurt the economy.  The fortunes of the global economy have also taken a hit with higher returns on bonds prompting investors to repatriate money invested in emerging markets over the past few years when there were few other investment options.  But the rush of money leaving places such as India and Turkey has brought howls of protest as well as fears about the ramifications of the end of quantitative easing on international finance.

It is central banks that now have to make the next move.  Yet this could involve doing nothing.  The tightening of monetary policy was never going to be easy and the recent jumpiness of investors could be just seen as collateral damage.  This would be a prudent option if central banks believe that there is nothing else that they could do to dictate the directions of the market.  But, on the other hand, central banks may decide to wrest back control of the expectations of investors.  Such a course of action could be prompted by fears that interest rates on government bonds, which act as a benchmark for interest rates throughout the whole economy, are too high at a time when the economic recovery is just starting in earnest.  Since forward guidance has shown that mere words are not enough, central banks may have to act, possibly with more bond buying.  Such a shock would bring investors back into line and serve as a reminder not to second-guess central banks.  However, with central banks likely to be keener to step out of the limelight (for What's the rush?), investors are likely to be left to their own devices.