Thursday, June 29, 2017

Phillips Curve and The Central Banks

The recent market sell off followed by comments made by ECB Mario Draghi spooked investors worldwide. The market has misinterpreted his comments to be 'hawkish' rather then 'dovish'. The next day, markets went up again!  He did mentioned about being prudence, but at the same time he was also concern about the Euro zone inflation rate being less than 2%. (The ideal is 2% - 3%.)

Here comes the famous economic theory "Phillips Curve". Many economists think that it is not relevant in today's world but the US and ECB think the theory is still valid and they have been making economic decisions mainly on the unemployment rate and the inflation rate.

According to Phillips Curve theory, economic growth should come with rising inflation and falling unemployment rate as shown in the diagram below.

Hence, the US Fed Yellen and ECB Draghi have been tracking these 2 parameters closely to decide whether or not to raise interest rates. What we see in the US and the Euro zone are falling unemployment rate, but at the same time, the inflation rates have been low too due to the supply side factors such as low commodities prices, cheaper raw material, and rising productivity due to technology. Hence, the low inflation rate may cause the US Fed and the ECB to defer raising the interest rate to normalisation. The current interest rate for the US and the Euro zone are 1.25% and 0% respectively, this leaves little room for the monetary policy makers to play should there be another financial crisis. 

How about fiscal policy? Since 2008, the whole world have been pumping their economies with billions and trillions worth of constructions and government spending. For example, the government debt to GDP ratio for Japan was 250% while the US was 106% according to Trading Economics. 

In terms of Fiscal and monetary policies, there just aren't enough rooms to maneuver.

Many people are anticipating another financial crisis soon as we have seen one in 1974, 1985, 1997, 2008, if looking at this sequence, the next one could be in this decade?

Or may be not? I will be sharing on this topic on this Sunday July 2 2pm - 2:45pm at KLCC Convention Center POPULAR Bookfest Hall 5. Free full day workshop voucher to be given with the purchase of my new book.