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Unyielding

Quantitative easing in the euro area enters a new phase

Jun 11th 2016 |

TRY and try again. On June 8th the European Central Bank (ECB) started buying corporate bonds, in its latest effort to gin up inflation in the euro area. Prices declined slightly in May compared with the same month a year before; the ECB’s inflation target is just under 2%. The scheme has already helped boost the zone’s corporate-bond market. Doing the same to its economy looks a tall order.

The purchases form part of the ECB’s quantitative-easing programme, under which it is already buying €80 billion-worth ($91 billion) of public-sector bonds, covered bonds and asset-backed securities monthly. (Government debt, of which the ECB has amassed more than €800 billion, accounts for most.) To qualify, corporate bonds must be investment-grade and issued by euro-area firms other than banks.

Analysts reckon that €600 billion-plus of bonds fit these criteria. The bank hasn’t yet said whose debt, or how much, it will buy; from mid-July it will report holdings weekly. According to Bloomberg, first-day purchases included bonds issued by Anheuser-Busch InBev, the world’s biggest brewer; Generali, an Italian insurer; Siemens, a German engineering giant; and Telefónica, a Spanish telecoms firm.

The ECB is likely to be a hefty buyer. It can acquire bonds in the primary or secondary market, and can hold up to 70% of an issue. Some analysts guess it might snap up €5 billion-10 billion a month. That may be a stretch. Even if it bought a quarter of the likely total of this year’s eligible issues, calculates Suki Mann of CreditMarketDaily.com, a website, that would still only work out at €4 billion a month.

Yields tumbled in anticipation of the ECB’s entry. According to Bank of America Merrill Lynch, yields on investment-grade bonds have slid under 1%, their lowest for a year; those on high-yield (junk) bonds have fallen, too.

That suggests the ECB is achieving its objective: directly reducing companies’ financing costs. But if it buys less than expected, the rally could go into reverse. And whether cheaper borrowing will spark investment and inflation is questionable: in March, when the ECB unveiled its plan, investment-grade yields were a less-than-prohibitive 1.3%. The ECB is also funnelling cash into banks as fast as it can: another lending-incentive scheme starts this month. But it is lack of demand, not of funds, that is holding Europe back.

A history of violence

Evidence is growing that gun violence in America is a product of weak gun laws

Jun 18th 2016 |

WITH awful, numbing regularity Americans use high-powered, high-capacity firearms to carry out mass shootings. And with awful regularity, efforts to reform America’s gun laws in the wake of such tragedies fail. (Indeed, a recent paper published by the Harvard Business School found that a mass shooting leads to a 75% rise in measures easing gun control in states with Republican-controlled legislatures.) More than 30,000 people die in shootings in America each year; no other rich country suffers anywhere near that level of gun violence.

Opponents of gun control argue that such figures have things backwards. In their view, widespread gun ownership deters crime, and thus benefits society. Advocates of tighter restrictions on gun ownership disagree: they believe the spur to gun crime from the ready availability of weapons far outweighs the deterrent effects. Social scientists have long struggled to adjudicate, since, on the surface at least, the data are ambiguous.

Pro-gun groups point out that rates of gun ownership tend to be highest in rural, sparsely populated states, where crime rates are low. By the same token, over the past two decades, as the number of guns in America has risen sharply, crime rates have fallen. Yet even as the number of guns in America has grown, the share of households with a gun has dropped steadily. Research published in 2000 by Mark Duggan of the University of Chicago concluded that the homicide rate had been falling in tandem with the proportion of households where guns were kept. What’s more, the homicide rate was falling with a lag, suggesting that reduced gun ownership was causing the decline, and was not simply a side-effect of a falling crime rate.

Other studies have reached similar conclusions. An analysis published in 2014, for example, using detailed county-level data assembled by the National Research Council, a government-funded body, suggested that laws that allow people to carry weapons are associated with a substantial rise in the incidence of assaults with a firearm. It also found evidence that such laws might also lead to increases in other crimes, like rape and robbery. A recent survey of 130 studies concluded that strict gun-control laws do indeed reduce deaths caused by firearms.

Links between gun ownership and violence are less well established than they might be, in part because lobbyists for gun rights have pushed to reduce public funding for research on the issue. In 2013 the Journal of American Medicine published an article on this phenomenon, describing how in 1996, for instance, Congress ordered the Centres for Disease Control to spend less money contemplating how to reduce shootings.

The main difficulty for academics studying the link between guns and gun crime, however, is the lack of a true counterfactual. A researcher cannot hold all other things constant while varying the stringency of gun laws in order to isolate the effect of those laws on the incidence of violence. That leaves open the possibility that any reductions in crime following a tightening of gun laws may be rooted in other, unrelated causes. Crime rates have tumbled in many rich countries in recent decades, complicating any analysis of the role of guns.

Nonetheless, some events can come close to offering an informative counterfactual. The aftermath of a mass shooting in Australia provides one example. In 1996 a gunman killed 32 people with a semi-automatic weapon much like the one used in the Orlando shooting on June 12th. Australia’s lawmakers quickly passed strict and sweeping gun-control rules. Semi-automatic rifles and pump-action shotguns were banned, and the government offered to buy weapons already in circulation from their owners (a programme of comparable scale in America would reclaim an estimated 90m guns).

Australia has suffered only two shooting sprees since then, claiming a total of seven lives. A decline in the rate of killings with guns, which was already under way before these rules came in, accelerated rapidly. Total gun deaths including suicides also fell. Before the change in the law the rate of deaths from firearms in Australia was about a quarter of that in America; afterwards, it fell to about a tenth of the American rate. In 2014 America suffered about 10.5 fatal shootings per 100,000 people; Australia recorded just 1.

The safety catch

It is not just the relationship between gun ownership and gun violence that is becoming clearer. Evidence is also building that even relatively modest gun-control measures reduce gun deaths. An analysis published in 2015 in the Annual Review of Public Health noted that state laws banning possession of a gun by individuals under a restraining order for domestic violence reduce the incidence of “intimate partner homicide” by 10%. The same analysis reports that firearm homicide rates rose by 25% in the five years after Missouri repealed its law requiring permits to purchase a gun, even as the national rate nationwide fell.

Public-opinion surveys show widespread support for tighter controls on gun-ownership in America. Indeed, nearly half of Republicans, the party most sympathetic to gun ownership, favour a ban on “assault-style” weapons. Their will is frustrated, however, by a political system that enables passionate minorities to stymie legislation.

In 2013, in the wake of the Sandy Hook massacre, in which 20 schoolchildren were shot dead, two senators, one Democrat and one Republican, introduced a measure that would have required background checks on most gun sales. It failed to move forward despite a majority vote in its favour, because supporters were unable to assemble the supermajority needed to overcome a procedural hurdle. Seemingly intractable disputes in American politics do sometimes give way to overdue reform. More probably, America will make scant progress in dealing with its gun problem until it begins to resolve its broader political problem.

Why forecasts are necessary

Jun 18th 2016, 12:08 BY BUTTONWOOD

POLITICAL and economic debate is often a matter of competing visions, which means it concerns competing forecasts. In the heat of the EU referendum debate, I was struck by a financial adviser who tweeted me that he "derides all forecasts." Along with the attacks on the views of "experts", it adds to a worrying change in the tone of the debate that echoes theTrump campaign's disregard for facts.

It is a fair criticism that economic forecasts are often wrong; it is very hard to predict recessions in particular. The old joke is "How do we know economists have a sense of humour? They put a decimal point on their forecasts." But forecasts are inescapable. When the Leave campaign says that Britain will flourish outside the confines of the EU, that's a forecast. They may not put decimal points on their predictions. But that only makes it an imprecise forecast where it is harder to challenge the details.

Karl Popper famously made the observation that the usefulness of a prediction was related to its potential for falsification. "It will rain in London in the future" is a statement that is 100% accurate. But it is useless when it comes to telling us which day we should carry an umbrella. A statement that it will rain at 10.30 tomorrow is much more useful; it either will, or it will not. And if it doesn't, we can examine what assumptions used in the forecast turned out to be false. The vague assumptions of the Leave campaign are telling; it is hard to challenge the details when there are so few.

A valid criticism of forecasts is that, given their inaccuracy, one should not put too much weight on their validity. But that too is a default for the Leave campaign. It is betting the future of the country on its forecast that a significant change in the political and trading environment of Britain will improve the outlook. To take that risk, one would want lots of confirmation of the forecast from outside bodies like the IMF or OECD; instead the reverse is true.

Forecasts are built into investing as well. When a financial adviser tells a client to pick a particular fund manager, they are making a forecast that the individual manager will be able to outperform the market (net of fees) in the future. (Something that there is very little evidence that it is possible to do on a consistent basis.) They must also, if they advise clients on asset allocation, or run a pooled fund, make implicit forecasts. They must decide how much to put in bonds, cash and equities. In turn, that requires assumptions (forecasts) about the outlook for inflation, interest rates and economic growth.

When a finance minister sets the government budget for the next year, he or she must forecast the outlook for the economy (a weaker econnomy will mean lower tax revenues, for example). When a central bank sets the level of interest rates, they know that it may take 18-24 months before the impact of the change is fully seen in the economy. So they have to forecast the outlook for the economy over the same period. Of course, they cannot be certain. So the Bank of England uses a "fan" forecast, indicating the range of potential outcomes. 

Those forecasts may turn out to be wrong in two types of ways. It can turn out that the economic model does not work as expected; that, for example, lower interest rates do not encourage more consumer spending. In that case, the central bank will change the way it thinks about the impact of future rate changes. Or the forecast can be confounded by some external event; a collapse (or surge) in the price of oil, for example. 

So any forecast about the UK's future is subject to the second danger. What forecasts like the IMF are doing is to predict the impact on the UK economy of Brexit, other things being equal. And here they focus on two factors; the length of the outcome of trade negotiations and the uncertainty this will cause.

A decision by U.K. voters to exit the EU would set off negotiations between the U.K. and the rest of the EU over the terms of its withdrawal and over the details of its future relationship with the Union. The U.K. would likewise need to renegotiate trade relationships with the 60 non-EU economies where trade is currently governed by EU agreements.

These negotiations could drag on for years, leading to a period of heightened uncertainty and risk aversion, which in turn would discourage consumption and investment and roil financial markets. In the long run, most formal assessments agree that the U.K. would be worse off economically if it were to leave the EU, as higher trade and financial barriers would lead to lower output and incomes.

The IMF explored the potential impact of uncertainty on U.K. growth during the post-Brexit transition in two illustrative scenarios, referred to as the limited scenario and the adverse scenario). In both cases, the impact on output and employment could be significantly negative due to higher uncertainty. The longer this uncertainty persists, and the less advantageous the outcome of trade negotiations for the U.K., the larger are these short- and medium-run costs.

Clearly, there will be some uncertainty after a Leave vote (not to mention the political turmoil it will set off, with a change in government inevitable). And we know that uncertainty tends to be bad for investment. So it is not crystal-ball gazing to assume uncertainty will have an impact; it is a rational assumption. We can argue about the extent of the impact, not about its existence.

So my answer to the adviser is that deriding forecasts is a cop-out. We need to make forecasts all the time, and the very detailed forecasts of the IMF, OECD etc, at the very least give us a benchmark against which to check out assumptions. To deride all this as the guesses of "so-called experts" is very dangerous, not just to the livelihood of financial advisers, who claim to be experts themselves. Forecasts won't disappear if the experts stop. They will just emerge in the kind of vague, unverifiable form that the likes of Trump, with his promises to slash taxes, maintain spending and balance the budget, bamboozle the public.