Krugman, Phillips and Carney

A recent post by Paul Krugman defending the Phillips Curve and the unemployment/wage trade-off. I'd never dream of challenging someone so much better at economics than me but I've long believed that this is a defunct trade-off. The labour market is global, surely, and that means that workers have little bargaining power even if unemployment falls. There are exceptions in some industries, of course  but my underlying view is that the world has moved on. Not only that but here in the UK at least, consumer price inflation has been incredibly sticky and resistant to downward pressure from recession. Wage growth and inflation have become increasingly unrelated, or so it seems. 

Professor Krugman is much wiser than me and heaven forbid me from actually disagreeing, so I have spent part of the week playing with data. What I ended up concluding was: 1) The wage/unemployment trade-off in the US is OK but the inflation unemployment trade-off is all but invisible. 2) If you want to see a properly operating Phillips curve, go to Japan. And 3) if you want to see somewhere where the inflation/unemployment trade-off is far, far worse than in the US, come to the UK. Which makes the decision to put inflation and unemployment at the hart of the MPC's monetary policy framework, a little odd. And indeed the risk that we face is that although growth remains weak, and wages remain under downward pressure, inflation will remain high, eroding the credibility of the MPC's 'forward guidance'. 

In the interest of understanding the Krugman piece, I did my best to recreate the chart he uses to show that there is indeed a decent wage/unemployment trade-off in the US, using annual data from 1985 to 2012. That is below.

So far, so good! But if I then plot the same scatter chart for the Fed's favourite inflation measure, the core PCE deflator, I get much less helpful results.... 

I guess there's a relationship of sorts but really? This may not matter to someone who is defending the Philips curve, but the Fed is targeting the core PCE deflator, and so that is to a large degree what matters to policy. 

There are all sorts of reasons why this matters for the US (not least  don't be surprised to see unemployment fall while inflation remains very well behaved) but I really wanted to compare what is happening there to what is happening elsewhere. So look at the same charts for Japan...

Now that's a Phillips curve trade-off. A less internationalised labour market? And bizarrely, this is good news for Japan. In many countries, news that inflation is going up and unemployment falling would be a source of concern but if what you want to do is escape a 20 year deflationary disaster, this is great. Inflation expectations are going up and the so far, Abenomics is delivering. I think monetary reflation can work.

OK, now for the horror show.... here are the same charts for the UK....

So... since 1985 there's been very little relationship between wage growth and unemployment but insofar as one exists, higher unemployment correlates with faster wage growth. There's a far better correlation between inflation and unemployment but unfortunately the sign is wrong.  The upward slope means that low inflation co-exists with low unemployment. This says nothing about causality but it does suggest that the idea of a wage/unemployment trade-off in the UK, is perhaps a bit out of date. Maybe the economy grows faster with low unemployment, or maybe British workers are being forced to compete with workers elsewhere to prevent jobs leaving the country?

The unemployment/inflation trade-off is used as an easier way of looking at a trade-off between inflation and economic slack. We view falling unemployment as a sign that the economy is getting closer to its potential growth rate. Likewise, we look at inflation as a measure of slack, a sub-par economy taking inflation rates lower. But when so much of what drives inflation has nothing to do with the strength of the economy, that doesn't quite work. Transport, education,  water, gas, and electricity prices are all regulated to a greater or lesser degree. Rail fares and utility prices through a formula agreed with the government in order to encourage much-needed investment. The price rises to pay for cross-rail, a new generation of nuclear reactors, or repair to Victorian water and rail network, have nothing to do with the strength of the economy. Indeed, when the economy is struggling, any suppliers of services that are subsidised by the government (like local authorities), see their subsidy fall and have to respond by pushing price up faster.

I wish the MPC hadn't put inflation and unemployment explicitly into the mix for their forward guidance. I know they have left themselves so much wiggle room that they can ignore persistently high inflation, falling unemployment and focus on soft growth, but this just looks like a  policy import that makes no sense over here.

I hope to find find time to write about this, a cracking argument for capital controls from a London Business School professor, tomorrow evening....

QE, credit rationing and an obsession with housing

So what did central bank long-term asset purchases (QE) achieve?  There has been a fair amount of noise in the press after two Fed economists, Vasco Curdia and Andrea Ferrero, published a paper seeking to answer the question. 

The paper concludes that the effects are small and indeed, that forward guidance around the future path of interest rates is more important. Overall, they estimate that the boost to GDP from QE and the Fed’s forward guidance amounted to about 0.13%, while inflation was boosted by around 0.03%. Cue a typical response from The Telegraph, in which Richard Evans wrote ‘Did QE punish savers for nothing?’

The view within the Fed seems to be that the effects of QE are entirely due to the downward pressure that asset purchases have on bond yields. Hence the importance of forward guidance. Driving down long-dated bond yields helps, but locking in expectations of a protracted period of very low short-term rates helps more.  Personally, I think this is a pessimistic view of what QE has achieved, while also failing to address what I see as two negative side-effects of - firstly that it QE distorts asset markets and risks creating imbalances which will be dangerous in the long run, and secondly that it does nothing to address the weakness of loan supply, and demand for individuals and small businesses, only really helping those who can tap into capital markets (directly or indirectly). 

The UK MPC explicitly recognised the crowding out effect of QE from the start. UK investors sold gilts to the Bank of England and used the money to buy something else. The hope was that this would divert money towards the parts of the economy that were in need of investment. You could be forgiven for concluding that they mostly bought houses or foreign assets, since the housing market recovered and the pound fell and you could reasonably argue whether that helped growth much, but that's another story. 

I've always though the UK interpretation was more realistic - QE 'works' both by lowering borrowing rates and by forcing investors into less conservative asset allocation decisions. I have also, in the process, concluded that QE results in money being cheaper for those who can get it, but does not alter the fact that money is ‘tighter’ or more rationed overall. I reach that conclusion because large-cap companies and higher-grade borrowers who can tap capital markets directly, are helped by the effects of. If, in the UK, the Bank of England buys gilts off private investors, it stands to reason that some of that cash can be re-deployed in the corporate bond market instead, easing access for borrowers. But it doesn't do anything to alter the fact that banks are shrinking their balance sheets and bank lending is being constrained.

One counter to this is that the weakness of bank lending is down to weakness in demand, rather than a limit on supply. Thorsten Beck of Tilburg University  in particular, has done a lot of research and written reams on why SME borrowing has been cut back since the credit crisis. I would observe, that since the first 6 months of 2013 have seen UK non-financial private institutions issue, in net terms, GBP 11.8bn of new capital while over the same period  M4 lending shrank by £54bn, and monetary financial institutions net cash raising has been a repayment of £41bn, there is at least cause to wonder if QE has kept capital markets working while the banking system has been shrinking. Maybe that is because the SMEs, which are reliant on the banking system for funding don't want to expand, but at first glance it looks as though they are faring less well in this regard than their bigger competitors. 

Meanwhile, the margins that banks have been charging for loans have tended to be wider in the post-crisis period than they were before, and that does at least raise the possibility that the reason loan demand was weak, was that the price of loans were high. Is that rationing? A shift in the cost of funds for bond (and equity) issuers, relative to the cost of funds to anyone calling their friendly local bank manager, definitely rations money.

But it all comes down to housing, apparently....

At this point, I observe that 1) there is some (but not conclusive) evidence that QE has helped big companies more than smaller ones; 2) that if the US view that forward guidance is more important the UK is in trouble because forward guidance has sent UK market interest rates sharply higher; and 3) the good news is that bank loan spreads seem to be narrowing a bit, that the Bank's credit survey indicates that both demand for and supply of credit is increasing, and economic recovery (albeit patchy) is underway. 

However, when I call up people who work at British banks and quiz them about the data, they tell me that a large part of the answer comes from the UK’s obsession with real estate (in all its forms). Pre-crisis, up to 70% of lending was to real estate in one form or another – mortgages, companies investing in real estate, developers buying land, pension funds treating it as an asset class and so on After the crisis, two things happened. The first was that regulators told the banks they had far too much exposure to this sector. So they have retrenched. And secondly, bankers found out they had forgotten how to lend to anyone else. A generation of lending officers at the major banks don’t really know how to lend money to an engineering firm to buy new equipment to ‘make stuff’.  They haven’t ever really had to do it as the UK’s manufacturing base has been left to rot. They know how to lend money to a property developer to buy, develop and sell a piece of land or a block of flats. 

The net result is a lack of lending.  The banks needed to shrink balance sheets. They also paid more for capital that they could lend out. And they weren't very good at trying to lend to those parts of the economy that might have wanted money. Meanwhile, without doubt, the appetite to borrow has decreased in the real estate sector. .

So the collapse in bank lending is because the UK economy is just doing a really bad job of re-engineering itself away from an over-dependence on real estate. But hey, it's not all bad news! The housing market is recovering. And according to the RICS survey this week, it is recovering around the country. Maybe that's why the banks are  lending. Maybe that's  why credit demand is picking up. It’s all linked. QE has helped the housing market, and an economy which is (still, after all these years) crazily over-sensitive to real estate, is feeling better about itself. And bankers can get back to the only kind of lending they really understand. Once upon a time, we were a nation of shopkeepers, but the High Street was made redundant and now we are a nation of on-line shoppers and house-owners... 

Of course, if this is true, there's a big risk we just see a property bubble reflate itself, the economy give the impression of thriving for a couple of years and then we'll be back in a mess but hey, that's better than never having any fun at all and maybe the wise politicians who run the country will use the recovery to invest in regional, educational and industrial policies to really help re-balance the economy away from finance real estate, towards manufacturing and other 'real' industries. Maybe..... 

The forward guidance Hokey-Cokey

The Bank of England’s monetary policy committee, led by the redoubtable Canadian Mark Carney, is adopting ‘forward guidance’ with a commitment to keep policy rates at 0.5%) as long as the unemployment rate is above 7%, unless doing so makes them fear missing their inflation target, or causes inflation expectations to rise too much or causes financial instability.

The market reaction was firstly to sell the pound and lower interest rate expectations ahead of the release of the Inflation Report and the forward guidance announcement.  Then, the pound was sold and rate expectations lowered with even more vigour as the news was released, only for the market to think again, turn around and buy the pound, selling short-dated gilts as the day wore on.  Sterling has ended the day about a percentage point higher against both euro and dollar, short sterling futures have sold off (modestly, having reversed the earlier gains) and gilt yields aren’t very different from where they were yesterday. The FTSE 100 is about 1% lower, performing better than the Nikkei but falling more than the S&P.

This seems a bit like the Threadneedle Street Hokey Cokey!

The purpose of forward guidance is to ensure that those involved in the wider economy, rather than those active in financial markets, understand that interest rates will stay low for ‘a long time’. That allows people to be confident that the period of super-low rates won’t be reversed suddenly. As for the conditions attached to the forward guidance, they are there to make sure that no-one fears that the central bank is being irresponsible. Of course, that’s completely impossible – some people think current rate levels are daft, as it is. The choice of conditions which would requires the MPC to change course is chosen to be both ‘credible (ie, to show the Bank is doing its job properly) and unlikely to be met (ie, they don’t actually want to be raising rates before the unemployment gets below 7%).

So, how did Mr Carney do? Any inflation hawk will simply turn around and point out that making unemployment a specific target of monetary policy, as well as inflation, is dangerous. In practise, even the Bundesbank used to care about unemployment, but making lower unemployment an objective does mean the central bank mandate has changed from fighting inflation to helping the economy.

My main concern – and to be fair this was the case long before the announcement was made - is that targeting lower unemployment subject to where inflation (specifically CPI inflation) implicitly assumes that there is still a clear trade-off between the two, and the monetary policy should focus on the trade-off.  And if that assumption is wrong, there is a very real risk that any specific unemployment/CPI target that the Bank came up with, was in danger of being either too easy to hit or too likely to miss.

What happens if GDP growth continues to be sluggish (likely) but is accompanied by a further fall in unemployment (possible), while consumer prices rise but wage growth remains very weak (also likely)? At the moment the economy is growing at an annual rate of 1.4% (in terms of GDP), and the Bank of England forecasts (optimistically) a steady acceleration from here. Even this pace of GDP growth is seeing employment increase, albeit with much criticism of the kind of jobs that are created (see the whole debate around zero hours contracts). Economic growth may not slow and employment may continue to grow too, but  if we are creating 'the wrong sort of job',  why would we see a pick-up in wage growth. Maybe, as the economy shifts from a financial service focus to a manufacturing one, we will see wage growth pick up as skills shortages in manufacturing grow. Maybe we will see downward pressure on financial services compensation ease and maybe, even, growth will deliver better tax revenues and as the fiscal position improves we will see public sector wage growth pick up. But mostly, there is plenty of excess labour globally and that is what is making wage-bargaining so one-sided even in economies with some kind of economic recovery. But even if wage growth remains low, that won’t keep CPI inflation down. This week saw the news that rail fares may rise by 5% or more on some commuter lines in the terms of the deal with rail operators. Gas, electricity, transport and education prices are all insensitive to what happens to wages or indeed to the economy. CPI inflation in the UK is supply, not demand-driven and worse still, it isn’t supply of labour which drives it.

So my first concern is that at a time when rates should say low and help the economy rehabilitate, the focus on unemployment and CPI inflation threatens to get in the way. Mr Carney would not want to tighten in the face of modest growth, but not doing so would undermine BOE credibility, perhaps severely. And my second concern is that by telling markets rates are staying lower for longer but giving them unemployment and CPI inflation as guides to when things may change, we will see markets price in very low rates for 2 or 3 years, and then assume a steep rise in rates thereafter. And since markets are by their nature forward-looking, pricing in the steep rate rise in the 3-5-year horizon risks undermining any good work from the forward-guidance in terms of anchoring rate expectations in the first place. If I am to price in higher rates 5 years ahead, I will sell gilts and buy the pound now. Which I exactly what happened after the initial positive reaction to the policy announcement.

I expect we will now see a whispering campaign to clarify what forward guidance really means, and to make sue that we all understand firstly  that the MCP remains firmly focusd on fighting inflation, and secondly how clear they are that rates are likely to be down at these lvels for years to come. but I don't know if inflation expectations can be re-anchored, or if the nagging fear that when rates start to rise, they will go up quite a lot further and faster than those elsewhere, can be soothed with a few words.

Holidays, work and railway tracks

The French President is going to spend his summer holidays close to Paris,  in a hunting lodge atVersailles. Shades of Louis XIV? ask the papers. The British Prime Minister has jetted off to Portugal, carefully choosing to fly Easyjet. So the press has chosen to debate his holiday attire, down to what length of shorts it is acceptable for a middle-aged politician to wear these days. 

The amount of jibberish written about how and where people spend their 'holidays' is staggering. The sartorial nonsense is peculiarly British (Mr Cameron, wear something comfortable, that your wife approves of, and ignore the fashion snobs). The pressure on M. Le President to go on holiday but not actually be seen enjoying himself is equally French. But it all makes me wonder how old-fashioned (but not ancient) notions of holidays are surviving in a new era. 

The summer holiday was born of industrialisation, urbanisation and improved transport. Not to mention a desire to promote healthy living. The victorians built railway lines that allowed factories to close and send their employees to Blackpool, Dawlish and Scarborough to breath fresh air.  After the second world war the French promoted St Tropez for Brigitte Bardot and La Baule for Monsieur Hulot. And then along came Carry on Camping and Carry on Abroad. 

Once upon a time of course, there were no summer holidays. An agricultural society doesn't have them in summer, a subsistence economy doesn't have them at all. Wealth makes them possible and workers' rights makes paid holidays the norm. Perhaps  it's no surprise that we cherish them, or indeed that we're so horribly snobbish about them. Ibiza is better than Majorca is better than Benidorm.  Salcombe is better than Torquay  is better than Paignton, apparently. 

Yet I can't help feeling this downing of tools is a bit out of date.  I don't suppose for a second that David Cameron is really cut off from his work in his Portuguese hidey-hole. I don't go away without three phones and a couple of computers, so goodness knows what kind of communications gizmos are in his hand luggage.  In any case, waking at 7 in Spain is a lie-in compared to London and the last thing anyone else wants me to do is disturb them. So a swim, a cup of coffee, a check on the overnight news,  still leaves me time to read for a couple of hours before the children wake up. 

One reason I work on holiday is that I have more time to think, far away from commuting and  meetings. Another is that work  is (much) more fun than making sandcastles. That may confirm what a sad old fool I am but really, why would we spend so many hours studying for jobs, climbing (and then sliding back down) greasy corporate poles, if we didn't actually like it? If I was a professional footballer maybe I would need to rest tired muscles and bruised bones but an economist just needs time to think. 

Ah yes - thinking time.  The key to understanding financial markets, as much as anything else, is to avoid "thinking on railway lines"; that is, being willing to challenge consensual ways of looking at the world and in particular, being willing to challenge one's own thought processes.

There are two ways of doing this. The first is to expose thoughts to criticism from people who have no incentive to agree with me just for politeness' sake. There are people to challenge a view that,say, QE lowers the cost of credit but does so mainly for the best creditors - governments and those who can issue corporate bonds, rather than small businesses  - but those people are easier to find outside my work and social groups. And the second is to think, re-think and then think some more. And that requires time, and a lack of distractions. 

Since people who question my views are best found away from the office and since endless  meetings are the hallmarks of any office, it stands to reason the best place to really think outside railway lines, is as far from the office as possible. Maybe the question isn't why people work on holiday but why they spend so much of their working time in an office. This obviously doesn't apply to all jobs, but even so, for many I suspect that the answer has more to do with custom, habit and insecurity than anything else. 

There was an old lady who swallowed a fly...

There was an old lady who swallowed a fly. I don't know why she swallowed a fly; perhaps she'll die.

I don't know if you know this nursery rhyme, but the fly was the least of the old lady's problems.  She subsequently swallowed a spider (which wriggled and tickled and tickled inside here) to catch the fly. Then a bird (wasn't that weird), to catch the spider. A cat, dog, cow and finally a horse followed. She's dead, of course.

I can't help thinking that US monetary policy since the defeat of inflation in the 1980s bears some similarities to the behaviour to the old lady in the nursery rhyme. The Federal Reserve is charged with running policy in such a way as to keep inflation under control and the economy at full employment. But inflation is being kept at bay more by a global labour market and technological innovation than by anything the Fed is doing. The Fed doesn't have to 'do' anything very much to control consumer prices and this affects policy. Fed policy is geared towards reacting to periods of falling unemployment by ever-so-cautiously tightening (or un-loosening) monetary policy, because that 'seems the right thing to do'.

By contrast, at the first sign of economic trouble, the lack of inflation means that the Fed can go all in, cutting rates, allowing the dollar to fall and encouraging those who can to borrow more, in order to boost demand and help create the jobs that will get the economy back on an even keel. Indeed, we have been forced to re-think 'all-in' as we saw the Fed cut rates to 3% in 1993, then to 1% after the dot-com bubble burst and now almost to zero, with a huge QE programme on top.

Meanwhile, the United States' overall debt level has gone on going up. That's "OK" because 'net debt' is offset by asset price gains, and 'debt-servicing' is kept down by low rates. The periods of low rates have caused asset bubbles - sometimes in the US, more often elsewhere. But one man's bubble is another man's boom and asset price inflation is apparently less dangerous than consumer price inflation. Never mind that it represents a huge transfer of wealth from one generation to another, that it dramatically increases economic inequality or that asset prices have a nasty habit of coming back into line with the underlying trend of the economy eventually. What we are concerned with, is the unemployment rate and the only thing that could deflect the Fed's attention would be consumer - not asset - price  inflation.

So having swallowed a recession in 1990, the US sent down a 3% policy spider to catch it. Then a bird in 1998. Then a cat in 2001 and a dog in 2008. On that basis, the cow comes next and then the horse, and it all goes wrong. I thought that 2008 was going to represent the last leg of what the Bank Credit Analyst terms the Great Debt Super-cycle. I was wrong. But was it the second-last, or the third-last?

The Phillips curve - a dinosaur
At the heart of this, is the fact that monetary policy-making is still dominated by the Phillips Curve. AWH Phillips established that there was a correlation between inflation and the unemployment rate in the UK, between the mid-19th and mid-20th centuries. The conclusion was that high unemployment pushes wages down, and low unemployment pushes them up, and this is what drives inflation. Sounds simple and plausible. Milton Friedman responded by introducing the concept of the NAIRU (non-accelerating inflation rate of unemployment) arguing that since the labour force is  rational, you can't just pick a point on the Phillips curve where you choose a combination of unemployment and inflation. Unemployment would tend to gravitate back to NAIRU, and you could only hold it below that by accepting rising inflation and indeed, could only get inflation back down by keeping unemployment high.

I was reminded of how out-dated the Phillips curveseems when I read a post by  the BBC's Economics Editor, Stephanie Flanders in which she argues that the cause of the relatively low unemployment rate the UK enjoys now, is falling wages. That fits in with the Phillips curve view of the world, except in the small detail that the causality is the wrong way round. Low wages keep unemployment down, as opposed to high unemployment driving wages down. So what is driving the wage growth down in the UK?

The world of AWH Phillips was one of a closed economy where people could move between industries, but not between countries. It works less well when labour can move pretty freely around the world and when productive capacity and employment can also move at the drop of a hat, to places where labour is cheaper, or perhaps where tax rates are lower. And the Phillips curve doesn't work at all if we can't even measure unemployment.

A global labour market makes casual measurement of one country's unemployment rate somewhat redundant. When goods-producers can shift production at a moment's notice to a more competitive location, the going wage rate is determined internationally, not as a result of a domestic Phillips curve. When people can come and go from one country to another, they drive down costs in many new industries. Coffee shops stand out. And as a piece I read last week by Paul Krugman argues, an economy where the biggest and most successful companies don't actually employ many people, you have to look at the labour market differently. Not least when the driving force deciding where they hire people is the corporate tax rate more than the wag rate. Finally,  when we have seen a collapse in labour market participation rates in this cycle, we simply have no idea what even one country's real unemployment rate is. The 'underemployed' are people who aren't recorded as looking for work, but would love to work (or at least earn) more. And they will act as an anchor wage growth even as the 'official' unemployment rate falls.

The warning from all of this is that economic recovery may not drive inflation up, because I can't see what drives wage growth up in developed economies in this cycle. But while that's good, what it does, is lead to continued unbalanced monetary policy. The FOMC must know that current policy settings are dangerous, just as you would have thought the old lady would know swallowing a cat was a bit risky. But  there's no CPI inflation and that means that if the US economy were to lose a bit of momentum, perhaps as a result of a falling stock market and rising mortgage rates, the Fed would be sorely tempted to re-inject some monetary accommodation -  a metaphorical dog to get after the unemployment rate...

Are we really stupid enough to prefer 2006-2010 to 1995-1999?

I have spent the last week seeing investors in the US. there is a huge debate going on in markets at the moment about whether the US Federal reserve should, or will, slow down the pace at which they have been buying Treasuries, and what it might mean for markets. This note is a short update on the previous post I put on this blog - which was intended as a basic aide-memoire for anyone who wanted to understand a little about how the 1994 'bond crash' played out in financial markets. That period being a reference point for what happens when the Fed starts the process of exiting periods of extraordinarily accommodative monetary policy

The chart below shows US jobs and GDP growth through the 1990s. You can clearly see how in 1994/1995 (when the US Federal Reserve increased its target for Fed Funds from 3% to 6% in 12 months), employment growth slowed from around 350k/month to a trough of around 100k/m, and GDP growth slowed from 5% to 1%. Briefly. Now that is a pretty sharp slowdown and is the basis for arguing that the 'bond crash' represented at the very least a poor piece of policy communication on the Fed's part. Let's forget anything else going on in the world, and accept that if the Fed had either done a better job of preparing financial markets for the necessary monetary policy normalisation, or if they had tightened more slowly, the economy's path would have been smoother.

That's all fine. But what I find surprising is that even now, there is a general sense that the Fed should do everything in its power to avoid a repeat. "We remain unconvinced that the eventual tapering of the central bank's asset purchases will trigger a 1994-style bloodbath in the bond market", John Higgins of Capital Economics is quoted as saying in the Sunday Times today.

The sense that is conveyed is twofold. Firstly, that  there is a risk that 'tapering' could be as bad in 2013 or 2014, as raising rates from 3% to 6% was in 1994. And secondly, that the crash was so disastrous everything that can possible be done to avoid a repeat, should be - despite what we have learnt since.

Here is GDP and employment (and Fed Funds) in the period of the last policy tightening that started in mid-2004. This time, rates increased from 1% to 5.25% in 2 years. The start of the process still saw employment growth slow to 100k/m, but GDP growth held up much better  - until the end of the move. Then, of course, after the Fed had finished raising rates, everything went very, very badly wrong.

So I will concede that 1994 could have gone better. In particular, If the Fed had worked harder on communication, the markets would have been less surprised when the first rate hike was announced. But, the economy didn't slide back into recession and 1995 to 1999 was simply a very good period for the US economy. This, overall, was no disaster.

The 2004-2006 rate hike cycle by contrast, allowed asset prices to go on rising far too fast, for far too long. Allowed leverage to increase throughout the US and global economies. Again, this is not the place to argue against the general view that the great Crash was mostly caused by greed, and poor regulation. But just as Fed policy caused a slowdown in 1995, Fed policy helped cause a massive recession. So the exit from the last two significant periods of very easy monetary policy both have faults - but are we really supposed to err on the side of a 2004-2006 outcome because we must, at all costs, avoid a repeat of 1994-1995? . But are we that stupid? Employment growth running at 170k/m, and GDP at 2% justify accommodative policy, but not zero rates and massive bond purchases for ever.

Thoughts on trading

Legendary trader Paul Tudor Jones has got himself into troubled waters for comments he made in a discussion  in front of students and alumni of the University of Virginia about the impact of having children on female traders' focus. Blogger Finansakrobat was the first I have seen who dared to speak up in Mr Jones' support.

Mr Jones is trying to back-peddle on the interpretation of what he said. I have nothing insightful to say on the subject of childbirth and trading but his point (I think) is that macro trading requires total focus. There are lots of examples of women who do extraordinary things after they have children. But what makes a great trader is something Mr Jones knows a lot about. So it set me thinking.

Since the industrial revolution, it has become the norm for 'work' and 'play' to be separated for most people. The cry of 'TGIF' says that for many, 'work' is still place you have to go to to earn the money to pay for 'play', which happens elsewhere. But that model is breaking down. Lots of people take work home now, some work from home. And lots of people enjoy work as much as they enjoy the time they spend 'not working'. "Macro Traders" as described by Mr Jones, usually fit into this category. But getting work and non-work life into balance is important. I've worked in a firm where the CEO was having an affair as the firm fell apart around it and worse still, so were a worrying numbers of the rest of the senior management team. I would have thought that one secret of a good leader in a high-stress environment, is that he or she is either brilliant at separating work and home life, or has a very stable home life that doesn't distract him/her from the day job. Sir Alex Ferguson, for example, seems to fit into this mould of work-obsessive whose home life is a rock of stability.

Trading, as a career, is pretty simple. You use other people's money (and sometimes your own) to make bets and get paid if you get it right. But underneath that simplicity is a need for clear rules and understanding, and almost above all else, balance within a team. A group of traders who risk each others' money as well as other people's on a day-to-day basis, need to have clear rules about much risk they can take, and how much they earn as individuals in return for making money for their employer and their investors.

A simple example is a group of four people in an investment team They are all of a similar age and experience. Three of them have no debts, reasonably healthy bank balances, but not enough money to, say, buy a Caribbean island. Their 'dream' in working together in a fund is that they will make some money every year, grow the assets under management and maybe make a lot of money one day They definitely don't want to retire and die a slow death running down their savings, but they don't feel the need to 'bet the house' on a turn of the card - they can wait for success. The fourth member of the team through, has been through a divorce, has a young family and while he lives in a sumptuous house, drives an expensive car and wears a pretentious watch, he has a big mortgage as well.

This is a team (probably) doomed to failure because one member has completely different emotional (and financial) drivers determining how he trades. He's not trying to wait for a great trading opportunity while building a business slowly and carefully. He needs success quickly and in the world of finance, he has the tools at his disposal to try. A more aggressive trading style may work, but probably won't.

An aggressive trader can bring down a hedge fund or indeed, a bank. Defenders of female traders sometimes argue that they are less inclined to behave that way. I don't know if it's gender-specific at all. What I do know, is that in a small business, it is important for all the people in the business to have consistent goals and ambitions. Not identical, just consistent. In a trading firm, where one person's focus and style can undermine everyone's efforts and where decisions need to be made at work, or at home or on holiday (markets won't stand still and allow you to ignore them) this consistency of goal, ambition and style is all the more crucial. Mr Jones, I sense, understands this very well.

I have always found the intellectual part of trying to work out where markets are headed more interesting than the nitty-gritty of executing trades. The best traders I have worked with, by contrast, have enjoyed the psychology of markets as much as I have enjoyed the economics of them, and are far better at the psychology than I could dream of being. For better or for worse, they have tended to be able to make sure their non-work life doesn't interfere with their ability to focus on trading, too.