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Negative Interest Rates (Wonky)

ResponsiblyIrresponsible
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2/14/2016 8:14:58 PM
Posted: 9 months ago
Disclaimer: This post is *not* an endorsement of any particular policy -- rather, I'm responding to particularly unclever people who insist that a negative nominal policy rate necessarily ships into bank profits. This is, without question, an incredibly presumptuous conclusion that does nothing more than begging the question.

Here's how banks operate: they borrow short in the form of demand deposits, on which they pay a rate comparable to the short-term policy rate, and lend long -- think of mortgages, for interest.

So what determines these interest rates? Well, short-term rates are a function of central-bank policy: that's a tad simplistic because central banks don't physically *set* interest rates so much as nudge them in the direction -- or, in some cases, the anticipated direction -- of the equilibrium interest rate, which is set by economic fundamentals. Long-term rates, by contrast, are a function of three things: the expected path of the short-term rate -- if you, for instance, rolled over your cash into a series of short-term securities over some given maturity and then took a weighted average, the implication being that short- and long-term securities are at least rough substitutes -- inflation expectations, and the term premium, which is the return investors demand to hold a longer-term security: it's a function of (a) current and expected supply of securities relative to demand for those securities (think of QE, for instance, and the so-called "portfolio balance" effect) and (b) the market-implied probability of bad things happening (e.g., default risk).

Now, the yield curve is merely a graph of Treasury yields against maturities. If the yield curve slopes upward, this net interest margin -- the difference between the long-term rates they earn in excess of the deposit rates they pay -- is positive, in which case banks profit. If it inverts -- because, for instance, markets anticipate a downturn -- they take a considerable loss. If it's flat -- and it won't be perfectly flat, but let's say it "flattens" -- they obviously take a considerable hit, but might be able to get by with fees or outstanding fixed-rate debt holdings.

Now, what happens if a central bank pursues a negative policy rate?

Well, that probably means economic fundamentals merit a low policy interest rate to generate meaningful upward pressure on employment and inflation. State-contingent payoffs will likely fall and risk spreads might rise -- all else equal, the latter pushes up on long-term rates (though most central banks pursuing these measures have large balance sheets, so this isn't a big concern). On the flip side, the prices of legacy assets -- assets already on bank balance sheets -- will likely rise.

Now, what impact will policy have? Well, if the negative rate is passed onto deposit rates, banks are paying out a negative nominal interest rate to deposits -- i.e., they're paying out less, meaning their net interest margin rises. Note that there isn't a single case of negative interest rates at present where a negative rate on reserves has been passed on to deposit rates. This is, therefore, unlikely.

The bigger question, though, is what happens to the shape of the yield curve. Normally we think that the yield curve flattens when policy is eased and steepens when policy is tightened. Why? Because if rates are expected to fall, generally speaking they'll fall across the yield curve due to the fact that longer-term rates incorporate the expected path of the policy rate -- and the average expected policy rate will fall. In order to take advantage of these heightened capital gains, since prices move inversely to yields, people will flock to longer-term bonds, ergo flattening the yield curve. On the flip side, if rates are expected to rise, people will flock to short-term securities to shield themselves from the capital losses associated with rate hikes: demand for long-term bond falls and yields rise, and demand for short-term bonds rises, pulling down their yields.

But this isn't the case amid tightening in the US! In fact, it has never been the case in recent memory. The past five tightening cycles or so featured a flattening yield curve after the central bank tightened policy. Why? There are a few reasons: (a) headwinds heighten the expectation that the central bank will proceed at a gradual or muted pacing in terms of further rate hikes, even by virtue of the fact that the rate hike will be expected to slow growth and pull down the equilibrium rate further; (b) structural issues reducing trend growth and the anticipated long-run value of the policy rate; (c) risk aversion in the aftermath of the financial crisis; (d) tepid inflation expectations; (e) a global flight to safety; or (f) the perception that the central bank is unable to credibly hit its long-term inflation target.

Point (f) is perhaps the most crucial. If a policy is successful, markets should react favorably to it -- normally, people view this as rising equity prices and falling Treasury prices. The movement in share prices is pretty unequivocal: those rise both when growth expectations rise AND when the policy rate falls, via any discounted cash flow model. The movement in bonds, though, is a bit more interesting: indeed, easing policy may result in lower interest rates over the near term, but low interest rates are not a function of easy money: they're a function of tight money which pulled down the equilibrium interest rate and merits an extraordinarily low level of the policy rate. If long-term rates are low, that's a signal of the market expectations that interest rates will remain low for some time. If that's the case, then it means that markets anticipate that the existing policy is far too *tight* to actually generate a meaningful upward move in inflation, a meaningful upward movement in NGDP, and consequently a meaningful upward movement in the equilibrium real interest rate that would actually merit a steeper path of the policy interest rate.

So, back to the subject of negate interest rates: Let's say that a negative nominal policy rate is seen as expansionary: let's say the central bank is led by Narayana Kocherlakota, and he's pledging to do whatever it takes to return NGDP to target as fast as possible and is willing to unleash all monetary tools at his disposal to accomplish that end. Markets see the move as expansionary and trust that the central bank will achieve its target in a reasonable period of time: not necessarily that this one policy step unto itself will be sufficient to hitting that target, but that the central bank will adjust policy as necessary should its existing policy prove insufficient. They price in, over the intended forecast horizon -- let's say two years, since that's the generally accepted duration of monetary-policy lags -- that the central bank hits its target and consequently tightens policy as a function of improving underlying fundamentals.

What happens?

If you guessed that long-term interest rates rose, you were right.

What happens if long-term rates rise? Well, the yield curve steepened, did it not? Short rates fell and might be low for as long as is necessary to hit the central banks target, but over time they will rise to match the improvement in fundamentals. A steepening yield curve bolsters bank profits.

The punch line? A negative nominal policy rates will only harm bank profits INSOFAR as markets perceive it as insufficient to actually achieving the central bank's medium-term policy objective. If that's the case, money isn't "easy." If easy money stokes financial imbalances, no one should be complaining about easy money. (Hint: it doesn't.)
~ResponsiblyIrresponsible

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ResponsiblyIrresponsible
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2/14/2016 8:19:36 PM
Posted: 9 months ago
My apologies: normally people anticipate a favorable market reaction as rising equity prices and falling Treasury *YIELDS*.

And, in the final line, I meant that if easy money stokes financial imbalances, no one should complain about financial imbalances.. because money isn't easy.
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dylancatlow
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2/14/2016 9:29:02 PM
Posted: 9 months ago
At 2/14/2016 8:14:58 PM, ResponsiblyIrresponsible wrote:
But if markets do see negative interest rates as conducive to long-term growth, and if this belief is reflected in long-term interest rates, then doesn't that undermine any reason to believe that negative interest rates will stimulate the economy? If the effective rate of borrowing remains high, then what was the point of setting them at zero in the first place?
ResponsiblyIrresponsible
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2/14/2016 9:54:25 PM
Posted: 9 months ago
At 2/14/2016 9:29:02 PM, dylancatlow wrote:
At 2/14/2016 8:14:58 PM, ResponsiblyIrresponsible wrote:
But if markets do see negative interest rates as conducive to long-term growth, and if this belief is reflected in long-term interest rates, then doesn't that undermine any reason to believe that negative interest rates will stimulate the economy?

No, because low interest rates are not the actual mechanism by which easy money would stimulate the economy -- if long-term interest rates fall because of a fall in, say, term premia because either the Fed bought a bunch of assets and reduced the expected future supply, that's expansionary not because long-term rates are lower, but because the elevated balance sheet applied upward pressure on equilibrium rates and on NGDP expectations. If long-term rates fell by the public's inflation expectations fell, that would be contractionary. The reverse is the case if long rates rise because of an increase in inflation expectations.

Interest rates are a function of underlying fundamentals -- an output -- not so much a determinant of those fundamentals. If long-term rates were to rise, for instance, because of a giant spike in term premia and/or tight money -- the latter of which would only raise them temporarily -- that would be contractionary. But if what you're saying is true and the increase in long rates would actually offset the stimulus of a negative policy rates, long rates wouldn't move upward in the first place -- because the movement was entirely a function of the market expectation that they would. So it's a bit of a circular argument.

If the effective rate of borrowing remains high, then what was the point of setting them at zero in the first place?

High relative to what? This is a misnomer: if the equilibrium interest rate is expected to rise because the central bank's policy action was deemed credible and sufficient to achieving its employment and inflation objectives, what constitutes a "high" interest rate would be far different (higher) than it would be had the central bank been pursuing an excessively tight policy.
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Naturalmoney.org
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2/15/2016 8:03:39 AM
Posted: 9 months ago
Primarily real interest rates are a function of how much growth additional capital will add to the economy. If there is a lot of demand for goods and services, more capital can benefit the economy, and interest rates will be higher. Secondary, interest rates are the result of risk expectations.

What has happened? Since the industrial revolution there has been enormous capital build up. More capital may not be feasible any more as long as interest rates stay positive. Wealth inequality contributes to lower interest rates by increasing the supply of capital via reinvestment and not supporting demand.

With regard to risk expectations, we can say that there have been many innovations in the financial system to reduce and spread risk. You can think of central banking and derivatives (even though it is a controversial subject). These innovations have pushed down interest rates too.

But if there is so much capital, new capital will have low yields. For example, a new project may yield 3%. It may not be feasible at an interest rate of 2% considering the risk, but it may be feasible at an interest rate of 0% or -2%.

So, the lower interest rates can go, the wealthier we can be, as more and more capital can be employed with profit. The Industrial Revolution was an unprecedented capital build up enabled by lower interest rates. In fact, interest rates in the Middle Ages were much higher than they were in the 17th century.

In 1694 England started a central bank, which may have increased monetary stability, and lowered the risk of having bank deposits, so that interest rates could be lower. Just after that, the Industrial Revolution took off. So, we shouldn't be afraid of negative interest rates. Instead we should welcome them.

I guess many people have not thought about how negative interest rates may work so they come up with all kinds of assumptions that are false. The first one is, no one will lend at a negative interest rate. So, how come that yields on government bonds in Europe are negative? It simply proves that this assumption is false.
slo1
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2/15/2016 4:46:10 PM
Posted: 9 months ago
At 2/14/2016 8:19:36 PM, ResponsiblyIrresponsible wrote:
My apologies: normally people anticipate a favorable market reaction as rising equity prices and falling Treasury *YIELDS*.

And, in the final line, I meant that if easy money stokes financial imbalances, no one should complain about financial imbalances.. because money isn't easy.

If there were no such things as monetary imbalances then the fed would have no reason to sell or buy bonds or other financial instruments on the open market. The entire point is to push or pull liquidity from the economy.

Just like everything there is a point of diminishing returns. In the case of negative rates, zero is just an arbitrary number. The bigger question for Japan in this example is how long can Japan support its economy from deflation before an epic fail. So far it has been decades. Negative interest is an odd thing, but negative rates don't mean much other than approaching a greater risk point that manipulation of rates is no longer effective.
ResponsiblyIrresponsible
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2/15/2016 7:19:07 PM
Posted: 9 months ago
At 2/15/2016 4:46:10 PM, slo1 wrote:
If there were no such things as monetary imbalances then the fed would have no reason to sell or buy bonds or other financial instruments on the open market. The entire point is to push or pull liquidity from the economy.

That isn't what I meant -- "financial imbalances" is a fancy way to say "bubbles," but it's a rationale that I'm agnostic, at best, on.

There is a liquidity channel of monetary policy, certainly, and that on balance holds down liquidity premia in the case of a risk-averse flight to Treasuries, or something of that nature (probably offsetting the fact that holding onto securities unto itself reduces liquidity, insofar as liquid Treasuries are being replaced with reserves that will merely sit on bank balance sheets as excess). But this is separable from imbalances: imbalances are present when asset prices deviate from fundamentals (investors are, for instance, underpricing risk). There is not a tool in the Fed's toolkit that I know of, other than tightening monetary policy -- and that's a horrid one -- or macroprudential regulations that could actually lean against financial imbalances: if assets are priced beyond what fundamentals would dictate, certainly buying even *more* securities wouldn't be the solution: hell, that would make the problem even worse.

Just like everything there is a point of diminishing returns. In the case of negative rates, zero is just an arbitrary number.

I agree with the first point -- which is why the other poster is wrong in insinuating that real interest rates are a proxy for marginal product of capital -- but the second point misses the mark a bit. Zero isn't necessarily arbitrary: granted, there is no lower bound at zero *presently*, but that's because cash itself doesn't yield 0 percent in nominal terms -- there are costs to storing it, guarding it, etc etc. But the concept of the "zero lower bound" is predicated on cash yielding nothing.

The bigger question for Japan in this example is how long can Japan support its economy from deflation before an epic fail.

Their GDP deflator is actually at their 2 percent target last I checked and NGDP has been accelerating since the implementation of Abenomics. Despite the Q4 contraction of 1.4 percent -- which is to be expected since their trend rate of real GDP growth is something like 0 or 0.5 -- their economy is actually on far more stabler footing than most people would acknowledge, financial turmoil and flight-to-yen aside (though even *that* is a function of strong underlying fundamentals).

I have a far more rosy view of Japan -- and, for that matter, China -- than most people. I'm convinced that the bulk of the problems both face are entirely structural and natural and that financial tumult doesn't provide us with any useful information in this case. If anything, perceived risk might beget risk and that otherwise wouldn't exist. The real risk is in dollar-denominated debts held by EME's.

So far it has been decades. Negative interest is an odd thing, but negative rates don't mean much other than approaching a greater risk point that manipulation of rates is no longer effective.

Pretty much, though I'd quibble slightly with the turn "manipulate" since I don't think central banks "set" interest rates.
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2/15/2016 7:19:51 PM
Posted: 9 months ago
At 2/15/2016 8:03:39 AM, Naturalmoney.org wrote:

None of this addresses the OP in any way, shape or form.

I guess many people have not thought about how negative interest rates may work so they come up with all kinds of assumptions that are false.

I see many of them in this post alone.
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2/15/2016 7:35:29 PM
Posted: 9 months ago
At 2/15/2016 8:03:39 AM, Naturalmoney.org wrote:
Primarily real interest rates are a function of how much growth additional capital will add to the economy.

No, it isn't. If real interest rates are "high" -- which is a meaningless characterization, by the way, unless we're using the long-run Wicksellian equilibrium real interest rate as our benchmark -- or somewhere near the long-run equilibrium point, that means we're near full employment: we would expect growth to slow down as the Phillips curve becomes progressively steeper and prices more flexible. Movements in demand, of which capital investment is obviously a component (which you misstated below), don't have any effect on real variables, or real output, in the long run. Excessive NGDP growth, likewise, means distortions that might move the LRAS in some adverse scenario. This is a classic case of diminishing returns to capital present in literally any model (Solow, Cobb-Douglas, etc.) that considers MPK.

To the contrary, capital investment will actually have far *greater* effects of low levels of the real interest rate, because low interest rates -- relative to the Wicksellian natural rate -- are associated with high levels of labor underutilization.

More capital may not be feasible any more as long as interest rates stay positive.

I don't even know what you're saying -- I think you're trying to say that positive, or what you call "high" interest rates would discourage capital formation. Again, (a) that's a meaningless word if not compared to a benchmark equilibrium rate and (b) "high" rates are associated with high levels of resource utilization which encourages capital investment. So this isn't true.

Wealth inequality contributes to lower interest rates by increasing the supply of capital via reinvestment and not supporting demand.

First, investment is part of aggregate demand. A lot of people conflate AD with consumption -- most of them are arch-liberals who get their economic policy from Think Progress or whatever. They're wrong.

Second, that's not the mechanism -- and it's theoretical at best. You meant to refer to as rightward shift in the savings curve: that pushes down equilibrium real interest rates, and generally real interest rates track those. That means that to sustain any given level of nominal spending, real interest rates must be lower by a proportionality factor equal to the shift.

The rest is just.... I don't really know what to say. Some of it is right, but most of it misses the mark because this nature of "high" or "low" interest rates is entirely arbitrary.
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dylancatlow
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2/15/2016 7:47:12 PM
Posted: 9 months ago
At 2/14/2016 9:54:25 PM, ResponsiblyIrresponsible wrote:
At 2/14/2016 9:29:02 PM, dylancatlow wrote:
At 2/14/2016 8:14:58 PM, ResponsiblyIrresponsible wrote:
But if markets do see negative interest rates as conducive to long-term growth, and if this belief is reflected in long-term interest rates, then doesn't that undermine any reason to believe that negative interest rates will stimulate the economy?

No, because low interest rates are not the actual mechanism by which easy money would stimulate the economy -- if long-term interest rates fall because of a fall in, say, term premia because either the Fed bought a bunch of assets and reduced the expected future supply, that's expansionary not because long-term rates are lower, but because the elevated balance sheet applied upward pressure on equilibrium rates and on NGDP expectations. If long-term rates fell by the public's inflation expectations fell, that would be contractionary. The reverse is the case if long rates rise because of an increase in inflation expectations.

Interest rates are a function of underlying fundamentals -- an output -- not so much a determinant of those fundamentals. If long-term rates were to rise, for instance, because of a giant spike in term premia and/or tight money -- the latter of which would only raise them temporarily -- that would be contractionary. But if what you're saying is true and the increase in long rates would actually offset the stimulus of a negative policy rates, long rates wouldn't move upward in the first place -- because the movement was entirely a function of the market expectation that they would. So it's a bit of a circular argument.

First, I'm not sure why you think low interest rates do not have a stimulating effect on the economy? Isn't lowering interest rates one of the Fed's main tools to combat recession? That is, doesn't the Fed have to go *against* the economic current in setting interest rates? Second, I'm not actually claiming that long-term interest rates would rise in response to negative policy rates. I'm arguing the exact opposite. You're claiming that long-term interest rates would go up in response to negative policy rates, on the exception that negative policy rates would promote future economic growth. However, that expectation appears to be at odds with itself: if everyone believes it, then they will demand high long-term interest rates and thus stifle the very economic growth they predict.
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2/15/2016 8:00:21 PM
Posted: 9 months ago
At 2/15/2016 7:47:12 PM, dylancatlow wrote:
First, I'm not sure why you think low interest rates do not have a stimulating effect on the economy? Isn't lowering interest rates one of the Fed's main tools to combat recession?
That is, doesn't the Fed have to go *against* the economic current in setting interest rates?

I didn't say they weren't stimulative, per se -- if the Fed reduces IOR into negative territory tomorrow, that would likely be expansionary by reducing demand for base money. But there's also a broader question of why rates are low: and, once they're cut to, say, zero, what the consequences are in terms of evaluating the stance of policy.

I subscribe to Milton Friedman's view -- which happens to be correct -- that low interest rates are a sign of failure: it's a sign that fundamentals merit a relatively "low" level for the policy rate because the endogenous equilibrium rate has dipped vis-a-vis its long-run average (where it would be if we were at full employment).

So, sure, the act of lowering interest rates via easing monetary policy -- and there's a crucial difference between a lower IOR and a lower 10-year Treasury yield (i.e., plummeting long-term yields that we observe now are a function of a global flight to safety and low growth expectations: that's not easy money, it's a sign of failure)-- constitutes *easier* policy than if we hadn't reduced rates, but that unto itself won't necessarily spur investment because the underlying fundamentals are weak. The only real benchmark -- no pun intended -- is the equilibrium rate, which varies over time with fundamentals.

Second, I'm not actually claiming that long-term interest rates would rise in response to negative policy rates. I'm arguing the exact opposite.

I know. The claim I made is extremely controversial -- it shouldn't be, but it is.

You're claiming that long-term interest rates would go up in response to negative policy rates, on the exception that negative policy rates would promote future economic growth.

Not necessarily, and not even on the expectation that they would promote *some* growth. I mean, this is a classic case of the Lucas Critique in which markets perceive a change in the stance of policy as insufficient to achieving the Fed's goal, so autonomous spending absolutely plummets and IS / AD shifts left.

I'm saying that if a negative policy rate, coupled with a credible commitment by the central bank, creates the expectation in markets that the central bank will be able to achieve its target, we should observe upward pressure in longer-term rates. Long rates are a function of the expected path of the policy rate, and easier money that spurs growth should mean that interest rates over the future will rise: if money is easier today, rates should be higher in a year or two years from now than they would be if policy were super tight, which meant that the central bank had to either reduce rates again or it wasn't able to raise rates. This expectation will be priced into longer-term rates.

However, that expectation appears to be at odds with itself: if everyone believes it, then they will demand high long-term interest rates and thus stifle the very economic growth they predict.

Again, you're reasoning from a price change: higher long-term interest rates as a function of easier money -- of higher inflation and NGDP expectations -- are as expansionary as it gets. If there any case of it undermining itself, then long rates would fall because people would expect that the central bank would have to slash rates again.

Interest rates are a really, really poor metric of the stance and/or predictor of the success of monetary policy. Rather, they're a function of underlying fundamentals. A central bank might tell you that they're reducing interest rates to spur investment, but the only reason that might work is because the equilibrium rate has fallen unbelievably low. In reality, they're easing the stance of policy -- which might result in lower rates insofar as they increase the monetary base -- but the actual mechanism is impacting NGDP expectations, which is what spurs spending, investment and hiring and would coincide with a rise in long-term interest rates, consistent with the expectation that the central bank hits its target.

It's a question of why long-term rates rise. If they rise because of an uptick and term premia or because of a considerable unexpected *tightening* in monetary policy, that's completely different. I'm saying they're rising because of easy money.

Take the 1970s for instance. How high were nominal interest rates? (I'm not talking about Volcker from 79-82 -- that was caused by tight money). Nominal rates were incredibly high but real rates kept plummeting. That policy was far too expansionary, which is why Volcker needed to come in and shut it down: nominal rates were high not because of tight money, but because of excessively loose money. The inverse is true for the low interest rates during the Depression, where literally no one thought money was easy.
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2/15/2016 8:05:31 PM
Posted: 9 months ago
At 2/15/2016 7:50:13 PM, dylancatlow wrote:

The easiest way to characterize my position is that an actual easy-money policy that promotes the expectation of the central bank hitting its target will only reduce interest rates temporarily. The opposite is true for an actual tight-money policy: it will only raise rates temporarily.

Take the Fed's recent rate hike, for instance. What happened to long-term bond yields? They PLUMMETED. But how can they happen if the Fed just tightened policy? Isn't that expansionary?

NO!

Well, it could be expansionary in the sense that markets expect the Fed to slow down the pace of tightening: that would be relatively easier than if growth were low and markets thought the Fed would just go, "hey, screw you guys, we're raising rates anyway!" Likewise, the fall in long-term rates in the mid-2000s -- the so-called "Greenspan conundrum" -- was relatively expansionary not because long-term yields fell, but because of the reason they fell, which was capital inflows from China.

But even then it's a conundrum -- no pun intended -- because you could easily make the argument that the fall in yields is based on the market expectation that the appreciation of the dollar will stifle growth, and might lead the central bank to slow down its pace of tightening.

I guess what I'm saying is.. this is pretty complex stuff, and really requires digging into the underlying reasons that interest rates change.
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slo1
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2/16/2016 1:21:53 AM
Posted: 9 months ago
At 2/15/2016 7:19:07 PM, ResponsiblyIrresponsible wrote:
At 2/15/2016 4:46:10 PM, slo1 wrote:
If there were no such things as monetary imbalances then the fed would have no reason to sell or buy bonds or other financial instruments on the open market. The entire point is to push or pull liquidity from the economy.

That isn't what I meant -- "financial imbalances" is a fancy way to say "bubbles," but it's a rationale that I'm agnostic, at best, on.

There is a liquidity channel of monetary policy, certainly, and that on balance holds down liquidity premia in the case of a risk-averse flight to Treasuries, or something of that nature (probably offsetting the fact that holding onto securities unto itself reduces liquidity, insofar as liquid Treasuries are being replaced with reserves that will merely sit on bank balance sheets as excess). But this is separable from imbalances: imbalances are present when asset prices deviate from fundamentals (investors are, for instance, underpricing risk). There is not a tool in the Fed's toolkit that I know of, other than tightening monetary policy -- and that's a horrid one -- or macroprudential regulations that could actually lean against financial imbalances: if assets are priced beyond what fundamentals would dictate, certainly buying even *more* securities wouldn't be the solution: hell, that would make the problem even worse.

Just like everything there is a point of diminishing returns. In the case of negative rates, zero is just an arbitrary number.

I agree with the first point -- which is why the other poster is wrong in insinuating that real interest rates are a proxy for marginal product of capital -- but the second point misses the mark a bit. Zero isn't necessarily arbitrary: granted, there is no lower bound at zero *presently*, but that's because cash itself doesn't yield 0 percent in nominal terms -- there are costs to storing it, guarding it, etc etc. But the concept of the "zero lower bound" is predicated on cash yielding nothing.

The bigger question for Japan in this example is how long can Japan support its economy from deflation before an epic fail.

Their GDP deflator is actually at their 2 percent target last I checked and NGDP has been accelerating since the implementation of Abenomics. Despite the Q4 contraction of 1.4 percent -- which is to be expected since their trend rate of real GDP growth is something like 0 or 0.5 -- their economy is actually on far more stabler footing than most people would acknowledge, financial turmoil and flight-to-yen aside (though even *that* is a function of strong underlying fundamentals).

I have a far more rosy view of Japan -- and, for that matter, China -- than most people. I'm convinced that the bulk of the problems both face are entirely structural and natural and that financial tumult doesn't provide us with any useful information in this case. If anything, perceived risk might beget risk and that otherwise wouldn't exist. The real risk is in dollar-denominated debts held by EME's.

So far it has been decades. Negative interest is an odd thing, but negative rates don't mean much other than approaching a greater risk point that manipulation of rates is no longer effective.

Pretty much, though I'd quibble slightly with the turn "manipulate" since I don't think central banks "set" interest rates.

You are right in that they don't set other than their reserve rate. Maybe gently influence is a better term.

Thanks as always. I learn much from your economic posts.
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2/16/2016 1:23:12 AM
Posted: 9 months ago
At 2/16/2016 1:21:53 AM, slo1 wrote:
You are right in that they don't set other than their reserve rate. Maybe gently influence is a better term.

That and the ON RRP rate, yeah. And I would agree with that.

Thanks as always. I learn much from your economic posts.

No problem -- I always enjoy discussing these things with you. Cheers.
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Naturalmoney.org
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2/16/2016 8:13:07 AM
Posted: 9 months ago
At 2/15/2016 7:35:29 PM, ResponsiblyIrresponsible wrote:
At 2/15/2016 8:03:39 AM, Naturalmoney.org wrote:
Primarily real interest rates are a function of how much growth additional capital will add to the economy.

No, it isn't. If real interest rates are "high" -- which is a meaningless characterization, by the way, unless we're using the long-run Wicksellian equilibrium real interest rate as our benchmark -- or somewhere near the long-run equilibrium point, that means we're near full employment: we would expect growth to slow down as the Phillips curve becomes progressively steeper and prices more flexible. Movements in demand, of which capital investment is obviously a component (which you misstated below), don't have any effect on real variables, or real output, in the long run. Excessive NGDP growth, likewise, means distortions that might move the LRAS in some adverse scenario. This is a classic case of diminishing returns to capital present in literally any model (Solow, Cobb-Douglas, etc.) that considers MPK.

To the contrary, capital investment will actually have far *greater* effects of low levels of the real interest rate, because low interest rates -- relative to the Wicksellian natural rate -- are associated with high levels of labor underutilization.
I was talking about the natural rate all along (and I am not considering short term fluctuations you are talking about). I am just saying that the natural rate is near zero and is likely to remain near zero (for the reason I have stated, and if you don't understand this, you should read Pikety, but don't make it too complicated as the reasoning is straightforward and it only requires some basic arithmetic). As a consequence I think that risk-free rates are likely to be negative.

More capital may not be feasible any more as long as interest rates stay positive.

I don't even know what you're saying -- I think you're trying to say that positive, or what you call "high" interest rates would discourage capital formation. Again, (a) that's a meaningless word if not compared to a benchmark equilibrium rate and (b) "high" rates are associated with high levels of resource utilization which encourages capital investment. So this isn't true.
At least you admit, that you don't know what I am saying. I will not blame you for that. It might just be my communication skills. It was my intention to say, that given the amount of capital we have now, more capital will have such low yields, that we cannot have significant capital growth with positive real interest rates. But if you don't know what I am saying, then how can you conclude that it isn't true.

Wealth inequality contributes to lower interest rates by increasing the supply of capital via reinvestment and not supporting demand.
First, investment is part of aggregate demand. A lot of people conflate AD with consumption -- most of them are arch-liberals who get their economic policy from Think Progress or whatever. They're wrong.
Yawn. You apparently think that I am a complete idiot. And you make little effort to hide it. The investment may add to aggregate demand, but it should also generate a return. If the investment goes into another mobile phone factory, the price of mobile phones might go down, and returns on investments may go down, and therefore interest rates. It isn't that difficult.

Second, that's not the mechanism -- and it's theoretical at best. You meant to refer to as rightward shift in the savings curve: that pushes down equilibrium real interest rates, and generally real interest rates track those. That means that to sustain any given level of nominal spending, real interest rates must be lower by a proportionality factor equal to the shift.
This is how it works out. But wealth inequality does matter in this respect, because rich people reinvest more than they consume relative to others. That is not a political statement. It is just how things work. And this is a way to explan low interest rates. In other words, if the government doesn't redistribute income, the market might do it via the mechanism of interest rates.

The rest is just.... I don't really know what to say. Some of it is right, but most of it misses the mark because this nature of "high" or "low" interest rates is entirely arbitrary.
You are misreading it. And therefore you go off-track. Maybe it is my writing skills. Maybe it is your reading skills. Maybe it is both, I don't know. But it is much simpler than you think. I have seen educated people who understand it and think that it might work. So I am not convinced. You show evidence of not understanding it and you even admit it yourself.
ResponsiblyIrresponsible
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2/16/2016 2:14:29 PM
Posted: 9 months ago
At 2/16/2016 8:13:07 AM, Naturalmoney.org wrote:
I was talking about the natural rate all along (and I am not considering short term fluctuations you are talking about).

No you weren't -- but even if you did, that would likewise be wrong for the exact same reasons I mentioned above, because if real interest rates are relatively close to the natural rate, meaning they're HIGHER, prices are generally more flexible and the the benefits of monetary stimulus taper off. You don't need short-term fluctuations (even though they're not exactly "short term," but whatever).

I am just saying that the natural rate is near zero and is likely to remain near zero (for the reason I have stated, and if you don't understand this, you should read Pikety, but don't make it too complicated as the reasoning is straightforward and it only requires some basic arithmetic).

Lol, this is hilarious and incredibly patronizing. Of course I understand natural-rate theory: to the contrary, you're the one who wants to have your cake and eat it too on real rates -- low, but positive, real interest rates will simultaneously restrain credit AND prevent reaching for yield!

Inequality isn't even the predominant reason holding down natural rates, nor will it be the primary reason they won't reason much beyond zero for some time. It's mainly an issue of demographics and hysteresis -- and you'd know that had you read any of the literature on this.

As a consequence I think that risk-free rates are likely to be negative.

That's a bit hard when the Fed has set a fairly firm floor at 25 basis points which they're going to likely rise as time goes on -- it's called the overnight reverse repurchase, or ONRRP, rate. Look it up.

At least you admit, that you don't know what I am saying. I will not blame you for that.

lmfao, again, incredibly patronizing. It wasn't that I didn't *understand* what you were saying because nothing you've said is actually complex: it just didn't make any sense whatsoever because it's complete hogwash.

It might just be my communication skills. It was my intention to say, that given the amount of capital we have now, more capital will have such low yields, that we cannot have significant capital growth with positive real interest rates. But if you don't know what I am saying, then how can you conclude that it isn't true.

Because this is precisely what I surmised that you had said, and I rebutted it in my post, because your metric for what constitutes a "high" real interest rate is arbitrary and meaningless -- and you would understand this had you read Wicksel (and yet you somehow think you're in a place to lecture me on natural-rate theory).

Wealth inequality contributes to lower interest rates by increasing the supply of capital via reinvestment and not supporting demand.

First, investment is part of aggregate demand. A lot of people conflate AD with consumption -- most of them are arch-liberals who get their economic policy from Think Progress or whatever. They're wrong.

Yawn. You apparently think that I am a complete idiot. And you make little effort to hide it.

You shouldn't read meaning when it isn't there. I have no opinion on whether or not you're an idiot, and you shouldn't insert this in a feeble attempt to smear me. You made a claim that is demonstrably wrong and I'm correcting you. Smart people screw up all the time, and you have now.

Moving on...

The investment may add to aggregate demand, but it should also generate a return.

It's not "may," it will BY DEFINITION. Whether it generates a return is meaningless when it is by definition part of aggregate demand.

If the investment goes into another mobile phone factory, the price of mobile phones might go down, and returns on investments may go down, and therefore interest rates. It isn't that difficult.

Lol, again, INCREDIBLY patronizing.

Okay, investments in mobile phones increases, and insofar as productivity of mobile phone companies increases as they invest in capacity or whatever, you might see some prices fall -- but they've also probably hired more workers or more machines in the process with that investment and are expanding their capacity. In response to rising demand, prices would likely rise.

But I don't know why you think the inverse relationship between prices and returns has absolutely any bearing on this misconception you have that investment isn't part of demand.

This is how it works out.

Oh, I love this -- okay, tell me how it works. Let's go!

But wealth inequality does matter in this respect, because rich people reinvest more than they consume relative to others.

You keep using the wrong term -- you mean they SAVE more, which goes into investment so that, on balance, pushes down equilibrium rates. It doesn't reduce demand. If anything, it reduces the amount of nominal spending per a given real interest rate and pushes down the equilibrium rate. But that's only if you don't account for the rightward shift in the investment curve that pulls the equilibrium rate UPWARD. This would only even be the case if you assume a perpetual savings glut, which you're not: that's primarily a function of EME industrialization, and is already winding down as China, for instance, transitions its economy.

That is not a political statement. It is just how things work.

It's not either. You just don't know what you're talking about.

And this is a way to explan low interest rates.

A very weak way, but sure, the global savings glut is one way -- it's a key argument Larry Summers has made as part and parcel of his "secular stagnation" hypothesis. But even he wouldn't throw income inequality at the top of the list.

In other words, if the government doesn't redistribute income, the market might do it via the mechanism of interest rates.

Hardly -- capital gains primarily go to affluent people. Even if money is pouring into investments and thus reducing their yields, this type of broad-based arbitrage that would actually chip away at their overall returns just isn't there -- and that money certainly isn't going to poorer people without positions in financial markets.

You are misreading it. And therefore you go off-track.

I didn't misread or misrepresent a single thing you said. You're just wrong -- and the attempt to smear me to cover that up when you've even REPEATED those falsehoods in your next post doesn't exactly serve you well.

Maybe it is my writing skills. Maybe it is your reading skills.

It's your lack of economic skills.

Maybe it is both, I don't know. But it is much simpler than you think.

It's actually extremely complex -- not necessarily for me, but in general -- and you would know that had you actually understood what you were writing.

I have seen educated people who understand it and think that it might work. So I am not convinced. You show evidence of not understanding it and you even admit it yourself.

LMFAO.

No, I never said that at all, and the insinuation, even after this exchange and our last, that you actually know more than me -- and are even attempting to capitalize on meaning where it doesn't exist, where I even correctly interpreted your gibberish that I said wasn't immediately comprehensible (because it was wrong) -- is just incredibly laughable.
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Naturalmoney.org
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2/17/2016 7:56:37 AM
Posted: 9 months ago
... the insinuation, even after this exchange and our last, that you actually know more than me ...

No I wouldn't say that. But sometimes knowledge stands in the way of thinking.