ECB'sPEPPincrease,NFPandSingularity

The ECB announced that they will increase the PEPP program by another 600 bn Euro. The original PEPP ( Pandemic Emergency Purchase Program) was announced on 18^th March for 750 billion Euro and involved the securities purchases of a wide array of debt papers including government securities and corporate commercial papers. The purchases would continue until 2021 or until the time the ECB governing council sees the impact of the Covid 19 crisis still lingering. The Euro jumped post the ECB announcement and now trades at 1.1340. News about the German stimulus package of 100 bn Euro and a proposed 750 bn Euro pan European package has already rekindled the belief that the recovery will be fast, if not furious. Across the Atlantic ocean in the US, we have seen that the response to the pandemic has been even more decisive with the Fed promising unlimited help and close to 3.4 trillion USD relief by the US government. 

Continuing on the topic of the central banks’ massive responses, we remember having written previously about the tools and models which they use to formulate their actions. Lots of data and research goes into the creation of these models essentially to forecast how the monetary policy transmission would happen and what levers would be the most effective ones. The ECB uses the DSGE model (Dynamic Stochastic General Equilibrium) to prepare its estimates. Use of so many heavy and impenetrable words in the model name itself gives it an aura of infallibility.   

In 2010,  speaking in the Chidambaram Chettiar Memorial lecture, former RBI Governor D Subbarao speaks about the topic of physics envy by economists. He says that economists in their quest to compete with physics (largely due to their jealousy) have created complex models filled with elegant maths which gives them (and others) a false sense of confidence about the future. But he says that physics laws are immutable but the economic ones are not, which is why the economic prognostications often fall short. He also talks about the concept of singularity in physics which is at a time or an event when the normal equations no longer hold true.  Newtonian mechanics meets its coup de grace of singularity in sub atomic space. Subbarao says that the stress periods in economy are similar to  singularity events. But in economics the singularity situations are much more common and prevalent. Hence the base equations themselves become suspect. The current Covid situation is another example where the normal laws of demand and supply, inflation and monetary transmission have mutated. The validity of models is in question once again.

 Stock markets across the world are taking a breather after the relentless rally of the last few days, but broadly the mood remains conducive to risk, notwithstanding the unrest in the US and increasing shrill rhetoric between China and the US. Today will be the day when the Non-Farm Payroll Data will be released. The unemployment rate is forecasted to read 19.8% up from the 14.7% seen in April. Non-farm payrolls are expected to plunge by another 8 million after a 20 million down in the month of April.

The Indian rupee opens at 75.38 today and stock markets trade with marginal green. The new 10 year benchmark bond trades at 5.83 up 3 bps from yesterday’s close.