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Discussion Starter #1
Is anyone else looking at Canadian long bonds? I'm giving them a second thought after reading this Telegraph article.

Mind the gap: why the bond markets are signalling a depression

Virtually unnoticed, the yield on long dated pan-European sovereign debt has slipped below that on equities. So what, you might say; that's what happens when shares go down and bonds go up. But in fact this reversal in the traditional relationship between bonds and equities is an extraordinarily unusual event. It's happened only three times in the past 50 years. Alarmingly, all three of those occasions have been in the past decade. What are markets trying to tell us?

There are two ways of looking at the phenomenon. Either it is an aberration, and therefore a buy signal for stock markets, or much more worrying, it marks the final death knell for Europe's 60-year love affair with equities, and therefore the start of a generalised retreat from risk that will see the economy stagnate or worse for perhaps decades to come.
 

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I'm currently out of equities, but markets have rebounded close to the point where I'll get back in, but I'll wait a few weeks to see where things go.

I'm skeptical about the risk of deflation, at least in Canada. If it happens, it will be because of politics, not a failure of government or central banks. The Bank of Canada has a singular mandate to achieve 2% inflation. If it needs to, it will start up the printing press and print our way out of deflation.
 

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Discussion Starter #4
I'm currently out of equities, but markets have rebounded close to the point where I'll get back in, but I'll wait a few weeks to see where things go.

I'm skeptical about the risk of deflation, at least in Canada. If it happens, it will be because of politics, not a failure of government or central banks. The Bank of Canada has a singular mandate to achieve 2% inflation. If it needs to, it will start up the printing press and print our way out of deflation.
The only problem with that concept is the demand equation. Using monetary policy to increase demand does not work, at least not historically. (pushing on a string, as they say).

Mike Shedlock (Mish) has a great post today on deflation. I think i actually understand all of it. (I am finding deflation a hard concept to wrap my mind around)


Are we "Trending Towards Deflation" or in It?
 

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Mike Shedlock (Mish) has a great post today on deflation. I think i actually understand all of it. (I am finding deflation a hard concept to wrap my mind around)
This whole talk about deflation is economist "geek-speek" IMO. For all I care, there is inflation in goods and services of essential use since 2008, and it's getting worse.
Every few months prices of household consumption goods creeps up by a few cents (food, cleaning, groceries, utilities, telecom, pretty much everything that we need on a daily basis).
And now there is HST.
Followed by the new eco-recycling fee since July 1st.
It's all inflation to me.
 

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I think we have seen plenty of evidence that printing money can create inflation (Zimbabwe, pre-WWII Germany, etc.). It might not be able to create demand, but that is not the Bank's mandate. At the very least, we can get to something like 'stagflation', except with reasonable inflation rates. But deflation is very harmful to demand, as it causes people to hoard money rather than consume, since it creates a positive real return on holding cash (whereas the BoC tries to create a negative 2% real return on cash).

Harold: you're misunderstanding the debate. No one is saying that we are currently experiencing general price deflation, though inflation rates are quite low. The fear is that we could experience deflation, as Japan has.

You've mentioned a few areas where there has been price inflation. Generally, though, price levels have been rising quite gradually.
 

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I'm currently out of equities, but markets have rebounded close to the point where I'll get back in, but I'll wait a few weeks to see where things go.

I'm skeptical about the risk of deflation, at least in Canada. If it happens, it will be because of politics, not a failure of government or central banks. The Bank of Canada has a singular mandate to achieve 2% inflation. If it needs to, it will start up the printing press and print our way out of deflation.
I disagree with you about the BOC's inflation targets. The BOC aims for inflation within 1% - 3% targets: 2% is just the midpoint of the BOC's acceptable range i.e. the BOC won't throw money out of helicopters if the inflation rate hits 1.9%. In fact, some research done by the BOC has advocated setting an even lower inflation target. See www.financialpost.com/news-sectors/urged+reduce+inflation+target/1936383/story.html

I also believe that deflation is unlikely. There are close to 7 billion of us all competing for scarce resources, and central banks have been creating money. Once the velocity of money increases even marginally we will likely experience inflation. Most of the news we get is North American-centric. The emerging markets are still growing rapidly.
 

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1.9% CPI is not deflation. While their target range is 1-3%, it's generally accepted that they target 2.

The article you link to mentions a CD Howe proposal for 0-2% target. I'm not convinced that lowering the target range is wise. It gives us less ability to create negative real interest rates when necessary. It also makes it harder for the economy to adjust given sticky prices, particularly for wages. Personally, I'd rather price level path targeting. This would help make inflation effects very predictable over long time frames rather than allowing short-term events to divert inflation off its expected course.
 

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1.9% CPI is not deflation. While their target range is 1-3%, it's generally accepted that they target 2.

The article you link to mentions a CD Howe proposal for 0-2% target. I'm not convinced that lowering the target range is wise. It gives us less ability to create negative real interest rates when necessary. It also makes it harder for the economy to adjust given sticky prices, particularly for wages. Personally, I'd rather price level path targeting. This would help make inflation effects very predictable over long time frames rather than allowing short-term events to divert inflation off its expected course.
The CD Howe institute has called for a lower inflation target, but the article (later on) cites research from the BOC also calling for a lower inflation rate. Also the latest CPI for May was 1.4 %, yet the BOC is increasing interest rates. See www.statcan.gc.ca/subjects-sujets/cpi-ipc/cpi-ipc-eng.htm

I think the BOC looks at data besides the CPI. For example, the BOC and Dept. Finance have stated directly that they are worried about the level of debt that Canadians are taking on. The longer rates stay low, the more likely it is that some Canadians will take on too much debt. I suspect that's another reason to raise rates.

Here's the link to the BOC research www.bankofcanada.ca/en/review/spring09/amano.pdf
 

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BoC can look at and talk about whatever it wants. But it's only goal is 2% inflation.

The reason why it's raising rates is because they aren't looking at current inflation, but at their model of future inflation. There's nothing they can do to raise the May 2010 inflation rate, but they can influence inflation in May 2012.
 

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But it's only goal is 2% inflation.
No. First, the BOC's acceptable inflation target lies between 1% - 3%; 2% just happens to fall in the middle of the band. Second, like most central banks, the BOC has a dual mandate. It guards the overall economic health of the country as well as price stability. The only major exception is the central bank of the EU, which is based on the Bundesbank. Its sole mandate is price stability.
 

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Discussion Starter #13
........ The only exception is the central bank of the EU, which is based on the Bundesbank. Its sole mandate is price stability.
That's interesting (to me). Are you following these German court cases over the Greek bailout? I've only read a bit, but seems like the courts in Germany have the final say in the matter, and some editorials say there is an outside chance they could rule against the bailout as unconstitutional. It's probably just hype i suppose, but nevertheless, more added uncertainty onto the already big pile.
 

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BoC can look at and talk about whatever it wants. But it's only goal is 2% inflation. There's nothing they can do to raise the May 2010 inflation rate, but they can influence inflation in May 2012.
I agree that the BOC looks to the future. But let's consider the argument. If, as you say, the BOC's only goal is 2% inflation, then raising interest rates makes no sense (with recent CPI at 1.4%) unless the BOC's forecasts are so bullish that they see inflation at well above 3%. In other words, the BOC sees growth so strong that inflation will rise outside its acceptable band. This doesn't mesh with the BOC's recent statements, which have carried a tone of cautious optimism.
 

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That's interesting (to me). Are you following these German court cases over the Greek bailout? I've only read a bit, but seems like the courts in Germany have the final say in the matter, and some editorials say there is an outside chance they could rule against the bailout as unconstitutional. It's probably just hype i suppose, but nevertheless, more added uncertainty onto the already big pile.
Thanks for the info. I haven't been following the court cases. I'd be awfully unhappy if I were a German taxpayer. I'm still upset at bailing out the auto companies.:mad:
 

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I agree that the BOC looks to the future. But let's consider the argument. If, as you say, the BOC's only goal is 2% inflation, then raising interest rates makes no sense (with recent CPI at 1.4%) unless the BOC's forecasts are so bullish that they see inflation at well above 3%. In other words, the BOC sees growth so strong that inflation will rise outside its acceptable band. This doesn't mesh with the BOC's recent statements, which have carried a tone of cautious optimism.
What other goal could raising interest rates hope to accomplish? If you have only one lever, you can only target one output. The BoC has one lever, the overnight rate (unless you count things like jawboning).

The Bank would tighten long before its forecasts showed 3% inflation. If it expects inflation above 2%, it will tend to tighten. Think of it like a person driving their car down the road. They try to drive between the lines because if they go outside them, they'll crash. It's fine for them to be anywhere between the lines, but to help ensure they never go outside them, they aim for the centre of the lane. If they think they're going to drive right on the edge of the allowable zone, they'll correct toward the middle, because it's too close for comfort. If something unexpected happens, there is a higher chance they might end up outside the lane and crash.

The only other thing I would say is that the Bank tries to avoid large, sudden policy shifts unless they are necessary. That helps to explain why they are raising rates, gradually, now. In the analogy, it's like the driver trying to avoid the need to swerve at the last minute.
 

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I'd also note that moving the overnight rate to 0.25 was the monetary policy equivalent to pouring gasoline on a fire. It's really potent stuff, and can easily cause things to get out of hand. It's not at all unreasonable for the Bank to want to ease off on that level of economic stimulus, especially given that demand in Canada is recovering nicely. If that were to change, I wouldn't be surprised to see even more aggressive moves from the Bank.
 

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Discussion Starter #18
Thanks for the info. I haven't been following the court cases. I'd be awfully unhappy if I were a German taxpayer. I'm still upset at bailing out the auto companies.:mad:
Its hard to say how your average German taxpayer should feel. In one way, Germany seems to have a captive market for exports and prospering because of it, so this cost to the taxpayer might be seen as a case of maintaining the sphere of influence uber alles. Greece needs to discover oil.
 

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What other goal could raising interest rates hope to accomplish? If you have only one lever, you can only target one output. The BoC has one lever, the overnight rate (unless you count things like jawboning).
Actually, the BOC has more than 1 lever. And I don't discount the value of moral suasion ("jawboning"). Central banks can do "quantitative easing." Also, the BOC does talk to the finance minister who can implement policy changes. The BOC was an advisor to the gov't regarding changes to mortgages. See www.bankofcanada.ca/en/fixed-dates/2009/rate_030309.html

The Bank would tighten long before its forecasts showed 3% inflation. If it expects inflation above 2%, it will tend to tighten.
I agree that the BOC would tighten before inflation hit 3%. But the BOC's forecasts don't predict the strong growth that would cause a CPI of 3%. Again, the BOC looks at the overall economy. Abnormally low interest rates have contributed to housing bubbles in some parts of Canada. I think the BOC is concerned about the level of debt of Canadians. I suspect the BOC is raising rates for reasons other than forecasts of rising inflation. In other words, the BOC will be quite happy with positive GDP growth and CPI of 1.5%.

Think of it like a person driving their car down the road. They try to drive between the lines because if they go outside them, they'll crash. It's fine for them to be anywhere between the lines, but to help ensure they never go outside them, they aim for the centre of the lane. If they think they're going to drive right on the edge of the allowable zone, they'll correct toward the middle, because it's too close for comfort. If something unexpected happens, there is a higher chance they might end up outside the lane and crash.
I agree. That's the point of the 1% - 3% inflation band. AndrewF, I've always enjoyed your posts and found them informative. In the end, we are splitting hairs. I don't think there is anything magical about a 2% level of inflation; it's just the mid-point of the acceptable inflation band. For example, if CPI averages 1.5% over the next 2 years (with forecasts of more of the same), then I don't think the BOC will lower interest rates just because of the CPI.
 

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Being concerned about borrowing and low demand are at cross-purposes. Either they want low rates to stimulate demand, or they don't want low rates. If they want to restrict the ability of some Canadians to borrow beyond their means, do it through bank regulation and CMHC insurance eligibility changes, and this has been done.
 
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