The impact of NIRP on inflation: some empirical evidence

Another day, another round of lousy US data, another sell off at the long end of the curve, and another big move in the SPX.  Only this time the equity market, perhaps buoyed by tomorrow's quarterly option expiration, upset the recent playbook by surging to the upside.  It's probably not worth getting too worked up about the change from the recent market dynamic, given the proximity to triple witching.   What we can say is that yet again, hopes for a bang up quarter of US growth appear to be slowly ebbing away; the Atlanta Fed's Q3 GDP Now forecast has now slipped to 3%, the lowest level of this forecast cycle.

Hmmm, at this rate it won't be long before the represserati start calling for negative interest rates.  Oh wait, Ben Bernanke has already begun laying the groundwork for just such a call.  Macro Man had to laugh when he read Bernanke's piece; not only did he trot out the usual arguments from the modern central banking playbook, including a touching belief in the efficacy of real interest rates, but he failed to furnish any proof that they actually work.

Given that we now have a reasonable sample of negative interest rates in different countries, Macro Man thought that it might be useful to investigate the track record of negative rates in boosting inflation.   He looked at headline CPI in five economies: Switzerland, Denmark, the Eurozone, Sweden, and Japan, measuring it before and after the introduction of negative rates.

He looked at the 12 month moving average of m/m changes in CPI rather than y/y changes because it made it easier to adjust for Japan's consumption tax hike in April 2014.  It's also worth recalling that Switzerland has had a complicated policy regime, targeting both interest rates and the currency at various times, and intervening in both markets regardless of the ostensible target.   Macro Man dates the imposition of NIRP from the time when the 2 week repo rate went decisively negative in October 2011.

CPIs for the countries in his sample are displayed on the chart below; dotted lines represent the CPI before negative interest rates, and solid lines afterwards.

 
The chart is a little busy, with plenty of overlap.  A summary of the data is set out in the table below.

As you can see, there is scant evidence that negative rates have boosted CPI; in 4 of the 5 countries in our sample, inflation has been lower since the imposition of NIRP than it was in the two years prior.   The margins aren't small, either; the average delta of 0.083% per month works out to more than 1% lower on annualized CPI inflation.   Small wonder that central bankers prefer to talk about their theoretical frameworks when the empirical evidence is so poor!

 Now, a valid criticism of this approach is that trends in headline CPI are dominated by oil prices, which are frankly out of the control of individual national central banks.   As such, a friendly theoretician might claim that the results above tell you more about spare capacity in oil production than they do about the effectiveness of NIRP.  While looking at trends in core CPI might mitigate the issue, the varying calculation methods/weights might render it something of an apples-to-oranges comparison.  (Also, Macro Man didn't have all the data to hand.)

Instead, he decided to look at trends in CPI data relative to a control group, preferably one not impacted by tax or currency moves of a single country.  He decided upon the aggregate OECD CPI index, which represents a range of large economies.  Surely if NIRP were effective in pushing underlying inflation higher, we should see CPI in NIRP countries rise more (or, more to the point, fall less) than in the OECD as a whole.

Sure enough, the chart of relative CPI does indeed look different to that of headline CPI, with all of the inflation rates further from their nadir than in the previous iteration of the study.


When we crunch the numbers, however, the results are still not particularly impressive.   Again, four of the five countries in our sample have seen their inflation rates decline relative to the OECD as a whole since the imposition of NIRP, though the exception (Sweden) manifests the largest absolute value delta in the study.


At best, you could say that the results are mixed, and even that's being very charitable.   Sweden is, after all, a country with strong GDP growth, a large professional immigrant population, and a massive housing shortage in its largest city.  But of course, the authorities don't include house prices in their inflation measures, and didn't that work out well for the US last time?

That four of the five countries have seen inflation fall not only in absolute terms, but also relative to a group of large advanced economies that for the most part still have positive interest rates, does little to suggest that negative rates generate the intended impact upon inflation.   If anything, even the second study probably understates the issue, since the lousy CPIs of the NIRP countries are also included in the OECD measure.

The negative side effects, meanwhile, have been notable, even if Mr. Bernanke and other academics are happy to wave them away with a brush of the hand.   Then again, given that many of them enjoy juicy government-sponsored pensions, why should we expect them to know or care about the (as yet largely unpublicized) negative impacts on private sector pensions?

The most effective arrow in many policymakers' rhetorical quivers since the crisis has been the counterfactual.  ("Yes, things are terrible, but just imagine how much worse they'd be if we hadn't had the courage to charge savers a tax rather than paying them interest!")  In the case of negative rates, however, there is some empirical evidence that we can measure against some sort of control group.   And the verdict is not only have these courageous measures not made things better, they appear to have made them a little worse.
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Panda
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September 16, 2016 at 7:51 AM ×

The WSJ article today mentioned one easing proponent of the BOJ said “any grade-school student can tell with a little arithmetic” the BOJ can’t buy bonds forever, “but it’s strange to be deciding policy today based on some future limit when... we haven’t reached that limit.” So the intention is to push the pedal to the metal - nay, through the metal, until one actually hits asphalt? And as MM pointed out above - with no efficacy on inflation/growth. Not to mention all this hope pinned on Abe's fiscal stimulus on the horizon to keep all the zombies well-fed? It seems like the further they go into NIRP, Yen further appreciates, and if they back off, then Yen... still appreciates?

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Nico G
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September 16, 2016 at 8:10 AM ×

http://money.cnn.com/2016/09/16/investing/deutsche-bank-us-14-billion-mortgages/index.html?section=money_markets&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+rss%2Fmoney_markets+%28CNNMoney%3A+Markets%29

vultures vultures..... Das Bank is toast.

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Anonymous
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September 16, 2016 at 9:25 AM ×

Perhaps it's time to introduce the concept of evidence based economics.

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Anonymous
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September 16, 2016 at 10:36 AM ×

Objection your Honor. In my view, NIRP or QE won't be able to have an impact on CPI anytime soon but it's still efficient. It's done, in a world fully loaded of debt, to avoid "debt deflation". Potential growth has been falling for many reasons and if we look at the demographics prospects, it could continue to do so. So you need to have negative real interest rates, as a risk management policy, to ease the debt dynamic. If it works, maybe the animal spirit will revive, we could get out pf secural stagnation. But if you don't implement NIRP and QE, you take the risk that debt repayment will be the only game in town, the risk of "debt deflation". It will take time. It's far too soon to search for empirical evidence.

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Anonymous
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September 16, 2016 at 11:12 AM ×

Objection to your objection @ anon, 10.36am. The negative effects of NIRPs by far outweigh the positive ones. Specifically, we have an antiquated cash and financial system being experimented with by academic lunatics who can't predict the effects of their experiments, and yet they then postulate that they should do *more* of that crap (koz, you see, the first time around it wasn't *enough*). What a bunch of drivel. Destroying savings (=investments), destroying pension funds and insurance companies, distorting all asset classes via a faulty signalling system (resulting from the very nature of NIRPs) -- that should be enough to scare most reasonable learned individuals. But evidently not those arrogant "well-meaning" fools. If NIRPs aren't outlawed soon, it will be the end of capitalism as we know it.

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checkmate
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September 16, 2016 at 11:19 AM ×

Forget negative rates just consider low rate impact on inflationary aspirations. If low rates could achieve that goal the WTF has Japan failed so abysmally to do just that in over two decades. Let's just look at it from two sides of the ledger borrower and lender. The former benefits to some degree from policy ,but I would have thought it clear that the latter does not. So what exactly is the transmission factor that makes one think that former gains to a greater degree than the latter loses?
Bernanke is like the immunology specialist who frames virtually all of the health issue he sees within his own sphere of reference and looks for a solution within that context. In other words they frame the problem incorrectly to begin with and as such arrive at the wrong conclusions.
The place to start is tax. Tax cuts boost disposable income for all although they initially bring pressure to bear on public revenues ,but if the very real increase does transmit to the economy then growth will occur and the tax revenues will increase relieving that pressure. This is not a monetary problem and as such Central banks shouldn't even be trying to resolve it.

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Cityhunter
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September 16, 2016 at 12:04 PM ×

It's not a question of should/shouldn't, but a question of will/will not for CBs. Apparently there is no end of NIRPs... until inflation surprise arrives.

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Macro Man
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September 16, 2016 at 12:10 PM ×

@ Anon 10.36 So in a world fully loaded with debt, the policy measure of choice is to dramatically push up the price of debt? You don't need to have a PhD in econ (or perhaps you need to not have one) to see that that's pretty bloody stupid.

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September 16, 2016 at 12:32 PM ×

Anon/MM:

Think you both make good points actually.

In a normal world, not gone through the Looking Glass, you don't take care of debt burdens by incentivizing more debt, lowering rates to zero, and preventing a bubble pop, or even any economic slowdown at all, by inflating debt/credit markets in all ways. In history, this action would naturally lead to the bubble getting bigger.

Anon's point may be - that the world is so far leveraged, and the debt so big an issue, that even in 2016, a forced deleveraging, through policy, would still cause a crash/crisis.....so the best "hope" at returning to normalcy, of any sort, is to stretch out the cycle, ZIRP/NIRP attempts to do this. Problem with this is in free markets, it simply incentives taking on even more leverage...and urgency to deleverage is reduced...and the framework expected to continue ad infinitum for borrowers....

I take a look at Fed Communication Policy today, and how this in/itself has gone through the Looking Glass as well...

http://crackerjackfinance.com/2016/09/inmates-running-the-asylum-fed-policy-8-years-into-recovery/

CJF

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washedup
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September 16, 2016 at 12:41 PM ×

Well - its safe to say CB's are mostly academics who care way more about their reputations, and to be thought of as right rather than to be empirically successful - in other words, we can rule out the alternative where CBs hold a presser and admit failure with long faces as the stench of urine fills the room.

Aside from the obvious weapon of choice, i.e. the counterfactual, as someone mentioned, what would one expect them to do? I vote for 'nothing', and the ECB has already started in that direction - they are checking in to the ostrich farm and looking for cool patches of sand to bury their heads in as we speak, but lets not expect them to ever say 'we were wrong' - I am really beginning to think that in their heart of hearts, they know they are f@#ed.

BoJ talking about steepening as Bernanke talks about negative rates - lets try a cosine wave for the yield curve next maybe that'll do the trick.

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Anonymous
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September 16, 2016 at 12:56 PM ×

Babies...lots of them. It's not difficult at all to get them. Just make it a financial break-even for working families (mothers) opportunity costs included. We should aim for TFR rate 2-2.5.

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Bruce in Tennessee
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September 16, 2016 at 12:56 PM ×

Well, let's see..

It is 2006 and my banker has two businesses who've applied for funding. He's loaning money at say, 5% and offering CD's at 3%...so he has 2% to make all his overhead...

Now it is 2016 and he's offering money at 3% and CD's at 1%....

...Just examples...and probably not exactly what my banker is doing, but EVEN if he could still make 2%...(even if)..there is less money to go around. Why? Because in 2006 he was making five bucks on 100 and had three bucks in overhead..(payout on deposits)..

But in 2016 he made 3 bucks and paid out 1 dollar..(on deposits), BUT his fixed overhead, salaries, utilities, FDIC insurance, etc. have all increased...

His other expenses mean there is less money available for the businesses that want to borrow...better hope the housing market and equities don't collapse..(sorry, I meant "correct" not collapse!)....maybe he could move my bank to Mexico....?

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Anonymous
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September 16, 2016 at 12:57 PM ×

Washedup, this is exactly the problem with such "academics" (whom I already bashed earlier today). Imagine physicists behaved that way (never saying they're wrong when clearly the Universe tells them that they are). They'd be laughed off the proverbial stage. This is why economics is called the "dismal science" and no scientist-academic worth their salt will ever these guys seriously.

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Polemic
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September 16, 2016 at 1:17 PM ×

http://news.morningstar.com/all/dow-jones/us-markets/2016091411294/former-fed-economist-blasts-central-banks-frankenstein-lab-of-policy.aspx

Former Fed Economist Blasts Central Banks' 'Frankenstein Lab' of Policy

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September 16, 2016 at 1:30 PM ×

Debating what CBs should do is an exercise in futility...this is the framework they have with all their tools they will keep going down this road, there is no other option for them (apart from emphasizing the fiscal side kick in)
As for the FED it is unlikely that they will introduce negative rates when the next downturn comes. (dynamics point out that we already entered it) As J-hole made it clear, asset purchases will be a "normal" policy tool going forward. In their framework to get real rates negative there is not much else to do either cut rates negative or raise your inflation target from 2% to 4-5%, which I think it being debated across the globe as the next step. Obviously, question is will market participants react...I think yes but then you run the risk of inflation expectations taking off and your decades long anchoring goes out the window. The bottom line is that we are slowly entering a phase where legging into breakeven trades makes sense as real rates will stay low or go lower and CBs would start to come around the idea of raising their infl.targets.

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checkmate
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September 16, 2016 at 2:07 PM ×

Pol,
"My biggest worry is that the public will conclude that...capitalism is just socialism for the rich," he said"
All he had to do was a find a way of linking capitalism to monetary policy in that statement and he would have been on the money.

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abee crombie
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September 16, 2016 at 2:34 PM ×

Bernanke got a little too big headed bc his Amazing QE was really only verified with a rise in asset prices, most notably Equities which kept everyone happy. Draghi and Kuroda are having a much harder time lifting asset prices outside of Fixed Income but they seem not to care too much, which is frankly a pity on them. As much as QE distorts the system, the only way you are going to incentive real growth, via QE, is by increasing asset and risky asset prices namely equities. Risky debt investments could also do the trick if they led to new investment but all too often HY is just refinanced old crap. To get new investment you need to incentive equity. At least the US/Wall Street/Silicon Valley have done that well. Though to be fair total US economic investment/CapEx is still struggling.

There is no growth and free money in the EU and JP. Take a page from the US and juice the stock market to incentivize a little risk taking or go direct and lend/invest in startups. Thats my suggestion. Zero rates are no good if you dont do anything with it.

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wcw
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September 16, 2016 at 2:42 PM ×

@MM and other central-bank bashers, isn't lack of inflation an argument for even lower, i.e. more negative rates, not an argument against them? We've got many decades of data that suggest very high central bank rates restrain inflation, and very low ones promote it.

While the peanut gallery is submitting questions, another one: if current developed world central bank policies represent financial repression, where are the ballooning savings rates? China's gross savings rate is 50%. The US's is under 20%.

Last one, I promise: if the Fed should raise, then why? What are the economic mechanisms through which current rates do ill and which higher rates would do well?

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Anonymous
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September 16, 2016 at 3:18 PM ×

WCW -- lack of inflation (as measured by developed world governments, not necessarily how it "feels" to proper citizens) is primarily a result of (ageing) demographics and (advancing) technology on the "supply" side. On the demand side, it's been shown over the years that humans are not robots, to state the obvious, and cannot be made to alter their consumption patterns, just because the CBs want them to... Hence, monetary policies are inherently flawed, the closer we get to the zero bound. The distortions resulting from those monetary policies far exceed any (haphazard) benefits over the long run.

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Macro Man
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September 16, 2016 at 3:20 PM ×

@ wcw

re point 1: There is a belief that the impact of nominal/real interest rates upon inflation is linear, whereas there is some theoretical grounding to believe that at the extremes, the opposite is true (ie neo Fisherism.) Certainly the empirical evidence presented here suggests a non linear relationship.

re: gross domestic savings, obviously you have to look at it a bit through the filter of development cycles and demographics. In the case of japan, for example, gross savings has been steadily declining as more workers retire- so they have little income to save (but still spend.) On a global basis, gross domestic savigns is still at levels near the highs of the 1980-2005 period, which I suppose reflects the impact of repression.

Why should the Fed raise? A) to provide risk-averse savers with a little more income B) To lessen the threat of future financial instability by taking a bit of air out of ZIRP-dependent markets C) to provide signalling via the Fisher equation that inflation will not be low forever

Why should they not? Well, if you believe that at current levels rates rates offer few of the benefits of the normal rate mechanism (in terms of stoking inflation, growth, wages, etc) but all of the costs (in terms of negative real economy impact of a modest rate hike), then they should not hike.

Personally, I believe that the price of money is not really impacting the flow of /demand for credit that much in the real economy; rather, there are other regulatory factors that are dominating. As such, the sensitivity to a rate rise in terms of impacting the flow of credit should be modest, and should derive a net benefit for some of the reasons I touched on above.

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Anonymous
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September 16, 2016 at 3:45 PM ×

Agree with wcw. FED up with all this CB bashing. I wanted to say(I am anon 10.36), that you have to balances the cons of the CB policy with the pros. And one of the positive is that you fight the real risk of deflation (debt deflation), not a low CPI, in having negative real interest rates because you ease the debt dynamic. It's not a small one, in my view.

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September 16, 2016 at 3:46 PM ×

Fed's blindfold to inflation must be getting thin at this point. CPI printed .25% and y/y rises to 2.3%. Rest of year we are rolling off .19, .20, .18 and .15 so could see 2.4 or 2.5% on CPI by end of year. Housing is 2.58% from 2.45% and medical is 4.92% from 3.99% so big sticky items are growing fastest. Median inflation (the better measure) should be 2.6%.

I'd have thought TIPS would be screaming to close the gap to nominals, but nothing so far.

Shout out to Michael Ashton for keeping me abreast of inflation: https://mikeashton.wordpress.com/

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Macro Man
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September 16, 2016 at 3:55 PM ×

@ Anon 10.36 Can you explain to me how jacking up the price of bonds solves the problem of excess debt?

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wcw
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September 16, 2016 at 4:34 PM ×

@Anon1518, I'm not sure I follow. The ZLB means you have to keep real rates high?

@MM, in re Neofisherism, I found Kocherlakota's note on infinite horizons persuasive, but I do worry that's confirmation bias. A little internet search finds this exercise predicting instability, falling inflation and output, but maybe we're not talking about pegs. Let's try working through the intuition.

CBs raise. Depositor and floating lender income increases, bank and floating borrower income decreases. Sure, fine, just a transfer to lenders at this point. However, CP and mortgage rates are now up. Normally we assume this reduces credit demand and that reduced credit demand slows economic activity. Why is it different this time?

@MJ, CPI printed 1.1% YoY.

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Anonymous
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September 16, 2016 at 4:49 PM ×

Hi MM (from Anon 10.36)! First, I want to thank you for your work and this great web site! I am a long term admirer. Secondly, because global growth is structurally falling and should continue to do so, the debt burden will remain a huge risk for the private sector. I fear debt deflation. So ironically, it's a good thing the private sector has not borrowed much more thanks to NIRP and I won't conclude it doesn't work. Because slower credit + real NIRP will favor a comeback to more normal indebtness. Then you avoid debt deflation and, who knows, can hope for better days when the work is done. That's the positive impact of NIRP + QE. So bonds have to be expensive. Nevertheless, it's true it might create costly bubbles, that it is killing the financial industry and implements the euthanasia of the rentiers. So it might be a dangerous policy and don't know what is the good solution as we are trying to balance apples with carrots. But I just say that without NIRP, the debt deflation risk is far higher : that would be very dangerous. So if their policy works, we will have only the answer in many many years. I won't blame them as the task seem so difficult.

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Mr. T
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September 16, 2016 at 5:08 PM ×

IMHO people look at this backwards - the credit cycle is more effective at controlling capacity than demand. More global capacity results in lower prices. If you want higher prices, you need less capacity. Higher rates (via project hurdle rates or zombie-co's falling by the wayside) will take care of it. The effects on demand are so indirect its not worth bothering to try to measure.

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scepticus
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September 16, 2016 at 10:17 PM ×

NIRP is not a tool for re-inflation any more than ZIRP is. NIRP is in the long run (e.g. when all the bonds are gone, political apathy for ever expanding deficits etc) the only possible response to a long overdue de-leveraging. NIRP won't prevent deflation but neither does it cause deflation. NIRP is a symptom of an over-leveraged and top-heavy (as in inequality) economy.

Yes the CBs could raise short term rates but before very long all that will achieve is an inverted yield curve.

The way the yield curve ought to look at the moment (absent fiscal stimulus, bailouts etc, etc) is inverted, with the short rate near zero but slightly negative and the long end more negative than that. The rationale is that during deflation we have by definition a negative time preference thus this should compound along the curve to push the long end below the short in the same way positive time preference lifts the long end above the short end. With this view, short rates need not go particularly negative since the long end would do the real work.

The reason IMO why the CB's are reticent about NIRP is because yielding to deflation and moving to negative rates for the duration of that deflation is an admission that they have no real control in the medium or long run and as such removes their raison d'ĂȘtre. Now Bernanke is no longer part of the committee, he suddenly doesn't care about that any more. If you want a more conspiratorial reason one might say its because the poor, with no assets and no savings and only income via labour have the least to lose under NIRP while the rest of the asset owning class fund real-terms transfers to the bottom of the pile.

Really, on a level playing field any recession where the economy shrinks ought to be accompanied by negative risk free rates since gifting investors with a positive real yield (risk free) when the pie is shrinking is completely insane policy. When the pie is getting smaller for all capitalism ought to be able to operate perfectly well in 'compete to lose the least money' mode. Any investor who thinks this unfair is unworthy of the name. The fact that the exact opposite has been done for the last 50 years under the names of price stabilisation and 2% inflation targeting is precisely why there hasn't been a single instant of de-leverageing economy wide (including public debt in the picture) in that whole time and we have such a vast pile of claims on a future that cannot possibly pay them.

Time, I think, for a rather different tune.

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Basho
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September 17, 2016 at 11:26 AM ×


Ben Hunt (Epsilon) on why the Fed may well still hike next week:

http://www.salientpartners.com/epsilon-theory/essence-of-decision/

Like others here, it puzzles me why low (much less negative) rates are expected to boost economic activity. Given household financial assets vastly exceed their liabilities, the opposite seems more likely.

Scepticus, most interesting thoughts.

Yes, the impasse created by the long sorry history of central bank policies means competing "to lose the least money" is now a realistic description of the overall investment game. I also agree that how we get off this high ledge of overleveraging is the biggest question of all. However, doesn't further distorting pricing signals via policy driven negative rates risk delaying and complicating the resolution of this dilemma?

Most of our present troubles, it seems to me, stem from a long-standing, almost fanatical, official unwillingness to allow the reduction of debt ratios through conventional means; e.g. debt write-offs, repayments and conversions to equity. Instead, ever more desperate and artificial attempts are made to reduce them by trying to get the denominator to grow more rapidly than the numerator. Given existing structural imbalances and overindebtedness I suspect that's probably impossible and, in any case, whatever slim chances there are of "success" come with the very real risk of bringing down the whole system. The narrative of official competence is (finally) losing its mana and I suspect the territory that lies ahead of us if they persist in trying for an "easy" way out won't be in the least bit linear in character. Here be dragons, basically.

As for the right answer, I don't know, but maybe it requires the recognition that debt deflation, bogey though it is, may be the least painful option. Official efforts could then be devoted to trying for the fairest and most effective mechanisms, and to ensuring the system itself doesn't fail while it's underway. An awful lot of people would get hurt but I fear they're going to regardless and at least there would be a clear and desirable end goal. (As an aside, under such a scenario very high quality credits might naturally trade at moderately negative rates.)

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washedup
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September 17, 2016 at 5:12 PM ×

@Basho - liked the linked article - thanks for that.

You are absolutely right regarding the obsession to elevate the numerator over the denominator, which is really just a way to pretend the system is still capitalist because the alternative is uncomfortable to accept - I think the reduction of those ratios through 'conventional' means i.e. write offs and conversions are still the end game - the more pertinent question is, whose balance sheet will equities and debt reside on as that holy number is massaged to an acceptably low level - the issue has been that as long as a majority of the equity and debt is in the private sector, those write offs or conversions will be de-facto destabilizing for the economy vis the financial markets channel - what CBs are attempting to do (even if its not intentional or formal yet) in a glacial fashion, is move more and more of it to govt balance sheets where the de-leveraging becomes painless. Ignore the political and legislative challenges to do so for a second, and imagine if the Fed/ECB/BoJ own all govt debt, plus all corporate bonds and say 50% of all equity, you would wake up one day and everyone's debt obligation could be written off - such is the power of fiat currency.

Left to their own devices, thats what CBs would like - of course, in practice there are various institutional barriers, which tend to come down quite quickly when companies like DB with trillions in derivatives file chapter 11 (no, not predicting it, just making a point).

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scepticus
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September 17, 2016 at 8:08 PM ×

Basho, your comment suggests on the one hand that low or negative rates are artificial. The implication of that in turn is that it is not possible for a genuine market rate to be negative which in turn requires one adopt that central plank of Austrian thinking which is that time preference is always positive.

On the other hand you say at the end of your comment that yields on high quality assets could indeed be genuinely negative.

You can't have it both ways. Either the CB genuinely does control the direction of interest rates and is imposing NIRP against a market which left to itself would never feature negative nominal rates. Or alternatively, if you accept that interest rates can be naturally negative under certain circumstances you have to leave space for at least the *possibility* that the current situation is reflective of real conditions and the CBs are simply following/accommodating the trend.

Any investor in these times surely has to take a view on this one way or another so as to avoid complete analysis paralysis. What is your view?

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Basho
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September 18, 2016 at 1:28 AM ×

washedup,

Glad you enjoyed it.

Yes, like you I've often wondered if the endgame would be socialism by reverse takeover. What a tricky (and risky) road however.

Japan, as usual, leads the way. It's still holding together with excess reserves at over 50% of GDP and household currency and deposit holdings of about 170% of GDP so I guess hitherto unimaginable extremes are possible.

Still, as CB holdings rise under such a scenario, as well as a private sector absolutely awash with cash, presumably asset markets would be hit by the mother of all squeezes. Seems like the perfect setup for a Misean crackup boom. And, perhaps, a loss of confidence in the system itself and its currency.

Dull it ain't going to be.

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Basho
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September 18, 2016 at 1:29 AM ×


Scepticus,

Fair cop, and thanks for forcing me to re-examine the question. Seems this Alice in Wonderland period slightly discombobulated me.

So. I do think time preference is always positive. Also, empirically, far as I know there's never been an historical instance of negative nominal rates. If it didn't happen in the 30s, when deflationary forces were extreme, it's probably reasonably safe to conclude it won't.

As to whether central banks lead or follow, up until 2008 I think it was mostly the latter. Their contribution to the credit boom was primarily psychological through backstopping the financial system (and, implicitly, the markets). Now, with massive excess reserves and IOER etc etc, their influence is far more direct.

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scepticus
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September 18, 2016 at 11:53 AM ×

Glad that's cleared up Basho- just a couple more things though;

When you refer to time preference being always positive do you mean nominal time preference or real time preference (e.g. expected inflation adjusted)? The reason I ask is that since real interest rates are often negative I assume you must then be referring to nominal time preference only.

If you refer to nominal time preference, then how do you explain a nominal yield curve inversion (again, a relatively common historical occurrence) which to me looks like negative time preference even if the curve is positive in all durations.

Regarding historical NIRP examples I agree that the GD is a bit of a conundrum however there is the well known Swiss 1970's NIRP example as one precedent as well as one or two instances of brief spates of NIRP on bills during some banking crises in the 17th/18th century although for the latter I must admit I could not locate the sources when I went looking for them again just now.

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Basho
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September 19, 2016 at 1:30 AM ×


Scepticus,

Given perfect foreknowledge and understanding, I mean real time preference. Since none of us are so blessed, I guess we generally end up with some mixture of real and nominal positive time preference.

When I said time preference is always positive, by the way, I meant something terribly simple, banal really. On the demand side, for most people in most situations, having something today is slightly preferable to having the same thing tomorrow. On the supply side, lending money entails risk as well as the temporary sacrifice of its use and hence doing so for no return, much less a negative one, makes no sense. (In deflationary times I suppose it might, but only if there's absolutely no risk and the negative rate is less than the cost of storing cash.) The interplay of these factors should, in a market not artificially manipulated by CBs, always produce positive nominal rates.

Historical NIRP examples like the Swiss one are, I think, always artificially induced. In that case, for various reasons (principally the strong Swiss focus on monetary stability in a world going slightly mad), Switzerland was inundated with capital inflows. The SNB imposed penalty charges on those inflows in an attempt to prevent extreme currency appreciation. As for the 17th/18th century examples, I'm not familiar with them but would imagine they resulted from some extraordinary short term distortion.

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Anonymous
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September 19, 2016 at 3:02 PM ×

Basho, Scepticus, thanks for the thought provoking discussion!

Rossmorguy

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scepticus
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September 19, 2016 at 6:58 PM ×

Basho, I'm surprised you plumped for real time preference since there are copious examples of periods of persistent negative real rates during times at which according to your analysis there was little or no manipulation or financial repression. The 70's would be a good example. However, specifying the real-time-preference only scenario does mean that the Swiss example doesn't disprove your point since investors at that time could still get a real return on their dollars or whatever even while suffering a nominal loss. Real-time preference OTOH, does allow for NIRP as long as deflation is sufficient to provide a real return. In reality maybe inflation illusion means this is not the case.

Regarding supply of funds from investors I think you're right. But what portion of funds available are from those who simply want/need to defer consumption? Both SWFs and retail savers will often fall in the latter category. For example, loanable funds also arise as a result of insurance requirements from individuals and organisations; this is purely about mitigating future uncertainty and risk and nothing to do with investment. Insurance will remain in demand regardless of the level of interest rates and would still be present under NIRP. What kind of return the insurer himself needs to make entirely depends on what premiums he charges. With a sufficiently large premium he would be happy with a zero or even negative return from investing the premiums.

It could also be claimed that many services are preferable to access in future rather than now, healthcare being an obvious and massive one. Would a 25 year old, on the balance of probabilities wish to consume his share of healthcare services now or in 30 years time? There must be others.

I think a lot of people in the investment community tend to miss the fact that a good portion of market dynamics are not driven by investors making decisions about the terms they will invest under, but by those who have no choice but to do so. The fact that both categories of participants have historically been able to enjoy some better than zero levels of nominal and real return has tended to confuses the different motivations in peoples minds.

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Basho
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September 20, 2016 at 2:02 PM ×


Scepticus, sorry about being so slow in replying. It's been one of those days plus time zones don't always mesh all that well from out here in the antipodes . . .

I plumped for real time preference because I think that's what most participants who consider such matters would be aiming for (no matter how inchoately!). However, our perceptual and conceptual failings (together with the reality of what the market in its wisdom dishes up) often leaves us falling well short of that goal.

In general, I suspect periods of negative real rates principally reflect lags in comprehending and adequately dealing with relative paradigm shifts. As to whether real time preference allows for NIRP, my best guess is still that in an unmanipulated market, the relative unwillingness of lenders to go meaningfully below zero, together with the probability of at least a modicum of demand for borrowing at rates well above zero should combine to make it most unlikely.

Re supply of funds, no matter how attractive an insurer's premium income might be, would this much change their attitude on trying to maximise investment returns? While the two clearly aren't independent in terms of the overall bottom line, I think they are for the most part in practical daily working reality.

You're certainly right that there are services where delayed gratification is preferable. It's what I had in mind when I wrote "for most people in most situations". That said, is it possible looking at things in this way may confuse more than it clarifies? The fact that a 25-year-old prefers to get his health-care goodies when he really needs them somewhere down the track doesn't, to my mind, in any way change his overall positive time preference. In other words, I wonder if it isn't a mistake to tie the notion to particular goods or services.

Again, no argument with your contention that reality often doesn't allow investors to get what they wish for. However, that's part of what makes markets and I'm not sure that this really reflects meaningfully on the question of time preference.

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scepticus
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September 20, 2016 at 4:34 PM ×

Basho thanks for staying with the interminable questions; safe to say I understand your stance now :-)

I guess the jury remains out on this issue, with views on both sides of the argument (incl. posters in the comments on MM's latest post).

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Basho
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September 21, 2016 at 12:11 AM ×


Pleasure, Scepticus. Look forward to reading MM's latest and the comments.

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