No full fletch defaults and how interest will remain lower for longer
WHAT CDS MARKETS ARE DISCOUNTING (Variant Perception, 1 min read) CDS pricing could be reflecting the expectation that central banks will ultimately monetise recent fiscal stimulus. Hence, CDS pricing demonstrates the probability of a traditional credit event occurring (failure to redeem or pay coupons, debt restructuring ) rather than a full default.
Post‑Pandemic Interest Rates: Lower for Longer (Advisor Perspectives, 5 min read) A combination of a large private sector saving glut and implicit or explicit nominal yield curve control by central banks will keep interest rates lower even after the pandemic is over. The history of pandemics, interest rates over the past seven centuries and previous recessions all support this thesis.
Understanding Helicopter Money (MPRA, 7-page read) Article emphasis that helicopter money should be directed to affected firms to be more effective. This type of monetary policy should be avoided in normal times, but it might yield beneficial results in the current state of the European economy to stabilize unemployment rates in short-run.
Central Banks Can “Magically” Prevent Disinflation (Econ Lib, 6 min read) Article highlights how inflation in 2021 and 2022 is also likely to be weak and stand below 2%. Primarily due to the supply shock. NGDP level targeting or price level targeting (along a positive 2% trend line) should be adopted by the Fed to avoid deflation within the economy.
What policies can help EM and why inflation will make a comeback
The Making of Hawks and Doves (JME, 42-page read) Personal experiences of inflation influence the hawkish or dovish leanings of all members of FOMC since 1951. The resulting experience had a statistically significant impact on FOMC voting decisions, tone of their speeches and differences in their semi-annual inflation projections. Accounting for FOMC experiences yields better predictions of the fed funds rate.
Exchange Rate Policy in the COVID-19 Pandemic (PIIE, 9 min read) Economies with significant foreign-currency debt, sharp depreciation could be more inflationary than any benefit from greater exports (amid the crisis). Policies to help these economies include: providing access to central bank swap lines, increasing lending capacity, keeping markets open for exports from these countries and coordinated direct FX intervention by reserve-currency countries.
Even As We Dive Into Recession, Some Worry About The Return Of Inflation (David Smith Economics, 6 min read) Boost in money supply growth (monetary financing of government spending and QE), rapid post-crisis rebound in the economy and supply shortages (as international borders open only gradually) could be inflationary.
Lessons in Yield Management from 1940s and why CPI measures are biased.
How the Fed Managed the Treasury Yield Curve in the 1940s (Liberty Street Economics, 7 min read) Two key Lessons in Yield management from 1940 include; the shape of the yield curve cannot be fixed independently of the volatility of interest rates and debt management policies and, large-scale open market operations may be required, from time to time.
What drives inflation in advanced and emerging market economies? (BIS, 14-page read) Inflation expectations, output gaps, exchange rates, and oil prices impact inflation of individual economies differently. However, after the GFC, expected future inflation has become an important driver of inflation for both the advanced and emerging market economies.
The Responses of Consumption and Prices in Japan to the COVID-19 Crisis and the Tohoku Earthquake (JSPS, 14-page read) A study compares the responses of consumption and prices to the COVID-19 shock and the Tohoku earthquake in March 2011. The YoY CPI rose by 0.6% vs 2.2 percentage points in the wake of the earthquake. Consumer expected higher inflation after the earthquake, and lower in response to COVID 19. This difference in inflation expectations implies that the economic deterioration due to COVID-19 could be viewed as driven mainly by adverse aggregate demand rather than aggregate supply.
The True CPI Just Jumped (Econ Lib, 2 min read) There exist a CPI Bias. CPI calculation does not account for: a variety of available goods (loss of product variety due to shortages) and quality of goods (disruption of the international supply chain means using a substitute). During this crisis, CPI bias means that we fail to appreciate how much we’ve lost hence its effect is inflationary but may not be captured.
The ESF backstop and why ECB action is not enough
Olli Rehn: Economic Effects of the Corona Crisis and Measures by the Central Banks (BIS, 10 min read) The ECB’s timely and targeted stimulus can help the European economy withstand the COVID-19 crisis, according to the Bank of Finland governor, but a coordinated European fiscal response is also vital for small open economies like Finland.
The Fed Has Announced Unlimited QE to Include Many Asset Classes (Credit Writedowns, 2 min read) The Fed is now “buyer of last resort” for all investment grade assets and with the Treasury, via the ESF, backstopping this lending the government and central bank are now acting together.
Did the Fed’s Term Auction Facility Work? (Liberty Street Economics, 3 min read) An old blog but nevertheless relevant as the Fed reactivates much of its crisis toolkit, but not yet the TAF. This facility was found to work as intended with the announcement of term loans triggering a decline in banks’ liquidity premium.
Former Fed chairs on monetary policy and Lamont on helicopter money
Bernanke and Yellen: the Federal Reserve Must Reduce Long-term Damage From Coronavirus (FT, 5 min read) With the underlying cause of the current crisis very different to 2008 reviving parts of the GFC toolkit cannot fully counteract current economic stress. Policymakers must employ measures to ensure the economy can rebound quickly – such as ensuring credit is available for healthy businesses – part of which is by purchasing corporate bonds (article from 18 March and therefore before the latest Fed measures).
Why We May Need Helicopter Money (OMFIF, 3 min read) With the self-employed accounting for 15% of Britain’s labour force the UK should, according to former Chancellor Normal Lamont, turn to helicopter money to avoid further hardship. Universal credit and statutory sick pay do not go far enough.
A Proposal for a Covid Credit Line (VoxEU, 5 min read) Using the ESM for a new long-term Covid Credit Line would circumvent the problem of no joint debt issuance in the EU while allowing the worst effected economies access to credit, the cost of which would not be linked to individual fiscal positions.
Lane repairs Lagarde’s blunder and the case against OMT for Italy
The Monetary Policy Package: An Analytical Framework (ECB, 6 min read) In an effort to reverse the damage from Christine Lagarde’s blunder during last week’s press conference Phillip Lane’s blog noted that, the ECB “stand(s) ready to do more and adjust all of our instruments, if needed to ensure that the elevated spreads that we see in response to the acceleration of the spreading of the coronavirus do not undermine transmission” of monetary policy.
Why OMT is Not the Solution for Italy Right Now (Bruegel, 2 min read) OMT light, with minimal conditionality and a commitment to roll back stimulus once the crisis is over, could be a way to contain spread widening and financial contagion. But since it would require Italy to give up some of its economic sovereign at a time of national crisis and does little to protect the wider Euroarea, this is not the instrument to use.
The Fed’s Actions Sunday: All in on Monetary Policy; Partly in on Liquidity Support (Brookings, 6 min read) The Fed’s actions on Sunday will not end the worsening disruption from COVID-19 but they will nevertheless ease pressure in the financial system and leave the economy more able to rebound quickly when the health crisis subsides. Further actions could include more specific forward guidance and a resumption of both the Term Auction Facility and lending to non-banks.
Monetary and Financial Stability During the Coronavirus Outbreak (IMF, 3 min read) A co-ordinated effort to offset tightening financial conditions via rate cuts and liquidity injections is the optimal use of monetary policy in the current environment. Other crisis instruments such as targeted SME lending can also help. Banks can look to restructure loans temporarily, but financial stability risks must be monitored closely.
What the Fed can do a rates continue to decline and how QE and act as a substitute for rate cuts
The Decline of the 10-Year Treasury: Implications for Fed Policy (Macro Musings Blog, 6 min read) The ongoing decline in the 10-year UST yield leaves the Fed with reduced options within its current policy toolbox. To counteract this the Fed can use a dual reaction function where the money base is used as a target when rates are below zero, target nominal GDP and incorporating helicopter money.
Are QE and Conventional Monetary Policy Substitutable? (International Journal of Central Banking, 36 page read) Doubling the size of a central bank’s balance sheet is equivalent to a 3pp cut in the policy rate. But QE can only substitute effectively for rates cuts when LT rates have room to fall.
The Information Channel of Monetary Policy Has Disappeared in the US (VoxEU, 3 min read) Improved Fed communication (including release of FOMC minutes) and forward guidance on policy has removed the Fed’s ‘information advantage’ and led to the information channel on monetary policy – changed behaviour after an unexpected policy announcement – disappearing.
Lane on monetary policy under low rates and core PCE versus core CPI
Philip R Lane: Monetary Policy, Low Interest Rates and Low Inflation (BIS, 4 min read) Incremental, sustained easing is needed in a low interest rate environment while pre-emptive easing can also act against an engrained downward shift in inflation expectations. Fiscal policy is a powerful tool in this lower-for-longer environment.
Two Measures of Inflation and Fed Policy (Advisor Perspectives, 3 min read) The more stable measure of core PCE explains why it is the Fed’s preferred measure of inflation, but its disinflationary trend (currently at a below-target 1.63%) suggests Fed policy has not been effective.
Clarida on the Fed’s reaction function plus Riksbank starts e-korona trial
Financial Markets and Monetary Policy: Is There a Hall of Mirrors Problem? (Federal Reserve, 7 min read) Vice Chair Clarida states that the Fed does not react to moves in asset markets in isolation, but instead considers them alongside various surveys and model-based estimates to conduct forward-looking monetary policy.
All You Need is Cash (Bank of England, 6 min read) Firms that retain access to cash can continue to invest during a financing crisis providing a long-term competitive advantage versus those who rely on credit markets. Young, small firms are those which can benefit most.
Sweden Starts Testing World’s First Central Bank Digital Currency (Reuters, 3 min read) The Riksbank has launched an e-korona trial whereby digital central bank currency can be used for everyday payments, albeit in a test environment. The results of the one-year trial will be watch by various other central banks studying the possible introduction of CBDCs.
Effective Fed funds under different liquidity conditions plus the leftward shift in inflation distribution
How Did the Fed Funds Market Change When Excess Reserves Were Abundant? (New York Fed, 15 page read) The switch to significant excess liquidity following the financial crisis and introduction of renumeration on excess reserves (IOER) changed both the main players in the fed funds systems and their motivation. But the effective fed funds rate remained within the target range and in line with other overnight funding rates.
Inflation at Risk (Federal Reserve, 65 page read) Fed researchers find that tight financial conditions create “substantial” risks of low inflation with rising credit spreads shifting the distribution of inflation to the left. This adds to earlier explanations of anchored inflation expectations and liquidity constraints as the drivers behind low and stable inflation.
Forward-Looking Monetary Policy and the Transmission of Conventional Monetary Policy Shocks (Federal Reserve, 30 page read) Incorporating Fed forecasts and the introduction of forward-looking policy provides more consistent results of the impact of monetary policy on output and prices than has been modelled before.
The banks benefiting most from forward guidance to more Philips curve research
Inflation in a Changing Economic Environment (VoxEU, 6 min read) From choosing an appropriate measure of inflation, decomposing inflation expectations and understanding drivers of labour costs and the wider pricing chain, ECB conference participants shed light on the disconnect between inflation and economic slack in the Euro Area.
Operational Issues for Countries with Evolving Monetary Policy Frameworks (IMF, 57 page read) Monetary policy transmission in low and middle-income countries with volatile overnight rates and weak monetary policy frameworks can benefit from targeting short-term interest rates rather than reserve money.
Forward Guidance and Corporate Lending (Munich Personal RePEc Archive, 66 page read) Reduced borrowing costs and increased willingness to lend can be directly attributed to forward guidance from the Fed following the financial crisis. The impact is most pronounced for highly capitalized banks.
Action points for the ECB’s strategic review and what drives FOMC dot plots
What the ECB’s Strategy Review Must Do (Project Syndicate, 4 min read) Former Director of Research at ECB, Lucrezia Reichlin argues that the review must determine whether policy mistakes, poor coordination between fiscal, monetary and financial policies or structural factors are behind the persistent failure to meet the inflation target.
What Drives the FOMC’s Dot Plots? (Journal of International Money and Finance) Labour market data are key drivers of FOMC interest rate projections at all time horizons, while for longer horizons trade and markets news also matter. Inflation is not found to make much difference.
Inflation and Public Debt Reversals in Advanced Economies (IMF, 23 page read) Higher inflation will have a limited impact in reducing DM debt ratios. A 1pp increase in inflation would knock just 0.5-1pp off the debt/GDP ratio, with a higher and more persistent impact under longer debt maturities.
Emerging markets central banks forge ahead with digital currency
Impending Arrival – a Sequel to the Survey on Central Bank Digital Currency (BIS, 19 page read) Rapid development of CBDCs in emerging markets could see around 20% of the world’s population with access to digital CB money in the next few years. Sweden is among a handful of countries already running a pilot project.
The Interest Rate Puzzle (Stumbling and Mumbling, 3 min read) Lower interest rates have boosted house prices more so than equities because either; housing was previously under-priced, both markets are concerned over distributional risks between profits and wages, or housing is now over-priced. [Bearish housing]
A timely look at CB reserves levels and the impact on policy implementation. For Europe, a new measure to estimate the impact of ECB QE.
Monetary Policy Implementation with an Ample Supply of Reserves (Federal Reserve Bank of Atlanta, 47 page read) After last year’s repo spike this study looks at whether low or high reserve supplies at major central banks offer a more stable monetary policy. Unsurprisingly, the paper finds the Fed’s current policy of “ample reserves” to be the most prudent.
Predicting Downside Risks to House Prices and Macro-Financial Stability (IMF, 47 page read) IMF uses current house price overvaluation, excessive credit growth, and tighter financial conditions to jointly forecast higher house-price-at-risk (HaR) up to three years ahead. Tighter macroprudential policy is found to be the most effective way of limiting downside risks to house prices.
The Euro Area Bond Free Float and the Implications for QE (Wiley, 35 page read) The authors construct a new measure of “free float” to estimate the impact of ECB QE on bond yields, growth and inflation. They estimate QE reduced 10‐year bond yields in the Euro Area by around 30bps in 2015, and in 2016 produced a 0.2 positive impact on the output gap and 0.3pp on inflation.
Japan’s mixed experience with raising its inflation target and an insightful contribution to the ongoing Philips curve debate
Raising the Inflation Target: Lessons from Japan (Federal Reserve, 10 min read) Fed takes a useful look back at the BoJ’s 2013 decision to raise its inflation target from 1% to 2%. They find the new target combined with the introduction of QQE boosted growth but only partially on raising inflation (CPI remains below the pre 2013 target). Achieving the old, before adopting a new target is one lesson for other central banks considering such a move. ECB and Fed take note.
Why Has Wage Growth Been Subdued in the Advanced Foreign Economies? (Federal Reserve, 6 min read) The authors use several models to show that slower productivity growth and lower natural rates of unemployment explain much of the apparent breakdown in the relationship between unemployment and wages. Once this is taken into account the wage Philips curve is indeed alive and well.
Debt Has Not Been Caused by Low Interest Rates, but Higher Rates Would Topple the Whole World Economy (Naked Capitalism, 2 min read) Richard Murphy highlights the latest World Bank concerns on rising debt. Normalising monetary policy is not feasible in his opinion as raising interest rates would “fuel disaster and the most massive collapse”.
As the debate around the potential side effects of unconventional monetary policy rumbles on a former Fed Chairman presents a positive assessment of the US experience. A Yale professor reminds us that negative real rates aren’t so unusual after all.
The New Tools of Monetary Policy (Brookings, 11 min read) Ben Bernanke makes a strong defence for using QE and forward guidance – arguing that it provided the equivalent of 3% in short-term rate cuts. He argues that the Fed could use yield curve control, private asset purchases or even negative rates. But he is against raising the inflation target. He also doesn’t see Fed policy as contributing to financial instability or growing inequality. [Bullish stocks]
Negative Interest Rates Aren’t Such a Departure After All (Bloomberg, 4 min read) Yale professor Paul Schmelzing finds that real rates have declined for the last 600 years, falling about 1% every 60 years to near zero today. Moreover, significant portions of history saw developed economies operating under negative real rates. The only extended period without negative IR is 1983–2008 (“the Great Moderation”). [Bullish rates]
The Business Cycle Is Dying (Econ Lib, 4 mins) The frequency of recessions has reduced. This could be attributed to monetary policy becoming more effective. It is further argued that if the US avoids recession in few next years, the term ‘cycle’ will no longer be appropriate to explain the dynamics of the economy. [Bullish US]
Negative Nominal Interest Rates Can Worsen Liquidity Traps (Kansas City Fed, 22 mins) Andrew Glover, a senior economist at the Federal Reserve Bank of Kansas City, finds that negative interest rates (NIRP) would likely deepen a recession in a liquidity trap (self-fulfilling pessimism about aggregate demand). Regardless of whether NIRP cuts are large or small, it is always contractionary for the economy.
There’s a big debate around what objectives a central bank should have – most are thinking of refining the inflation target, yet some are calling for something more radical. Meanwhile, trust in the ECB is declining.
Public Support for the Euro and Trust in the ECB: The First Two Decades (Vox EU, 8 min read) Insights from surveys in member countries of whether the public still supports the ECB and single currency (monetary union). The main findings include: support for the euro is consistently higher than both trust in the ECB and trust in national governments. After the crisis of 2008-2013 public trust in the ECB had deteriorated and the rate of unemployment is the key factor explaining changes in support for the euro and trust in the ECB. [Bearish ECB]
Financial Stability Should Be Central Banking’s Prime Objective (Project Syndicate, 4min read) Former Chief Economist of Citi, Willem Buiter, argues that financial stability rather than stable prices should be primary objective of central banks. Argues for higher rates and also counter-cyclical macroprudential policy. [Bearish bonds]
Already, people are tempering expectations around Lagarde’s new run as ECB President. While others lament the anemic levels of inflation around the world.
The Limits of Lagarde | by Yanis Varoufakis (Project Syndicate, 5 min read) Varoufakis argues that for every euro that Draghi’s ECB printed to buy Italian public debt, it created two euros to buy German public debt. There was no economic rationale for buying bunds. Was Draghi remiss? Of course not. He laboured within absurd political constraints imposed by institutions. Lagarde will face the same. [Bearish Eurozone]
Quantitative Easing and Exuberance In Stock Markets: Evidence From The Euro Area (De Nederlandsche Bank, 23 pages) Controlling for other improving macro conditions, this study demonstrates that QE programmes coincide with exuberant investor behaviour which tends to persist the longer the QE programmes run. The central bank argues that macro prudential measures should be used to address these risks. [Bearish Euro equities and credit]
Inflation Trends in Asia: Implications For Central Banks (ECB, 27 Pages) This paper estimates trend inflation for the 12 largest Asian economies between 1995 and 2018 and benchmarks the trends to current inflation figures. They find that most of the decline in inflation in the region is explained by lower trend inflation rather than transitory shocks. [Bullish Asian bonds]
Inflation Remains in a Coma in Major Economies, Frustrating Central Bankers (Dr. ED’s Blog, 4 min read) Edward Yardeni believes Inflation is currently hibernating globally in major advanced economies. Powerful forces of aging demographics, technological disruption and large debt are responsible for this deflationary trend. Ultra low-interest rate is failing to re-ignite inflation and is driving stocks higher. [Bullish G7 bonds]
The ECB after the Crisis (ECB Working Papers) The ECB makes the case that its expanded responsibility to ensure the stability of the banking system, through the establishment of the Single Supervisory Mechanism (SSM), is the most far reaching action taken by the Euro-area. They argue that they can keep monetary policy and supervisory roles separate. [Bullish EU Financials]
Generation War on Inflation: Optimal Inflation Rates for the Young and the Old (Dallas Fed) Dallas Fed computes the optimal inﬂation rates for the young and the old in Japan. They conclude that the “optimal” rate for the older generation is negative due to their nominal asset holdings. An ageing population may lead to lower expected inflation rates in the long term. [Bullish JGBs]
There’s still a raging debate as to whether QE has inflated asset prices or whether policymakers should care about international developments. This week, we have pieces arguing ‘no’ in both cases.
A Tale of Two Financial Cycles: Domestic and Global (Bank of International Settlement) Big macro thinker Claudio Borio distinguishes between a domestic cycle (local fundamentals-driven, mainly affects property and credit ) and a global cycle (US monetary policy-driven, affects cross-border equity and bonds flows). He believes policymakers should focus on the domestic cycle, not the global cycle. [Bearish bonds]
Are Central Banks Manipulating Asset Prices? (Marginal Revolution) Argues that QE has driven asset prices – the average annual return of the Vanguard Total World Index is 8.9% on average over the period of QE which is in line with the 35-year average. [Bullish equities]
Notes from an Inter-planetary Monetary Anthropologist (Moneyness) JP Koning fantasies a planet “Zed” with a religious craze of setting a minimum interest rate of 2% on deposits. With the planet’s economy slowing down, its inhabitants enter a debate to justify the need (or need not) for a lower interest rate.
Consumption, Credit, and the Missing Young (Boston Fed) The US now has a record number of young adults without sufficient credit history since the “CARD” Act was introduced in 2009. This portion of the population could drag down consumption growth on a state level. [Bearish US growth]
It’s clear that economists have got a lot wrong, but mainstream thinking isn’t changing much. Moreover, the Fed seems reluctant to try anything new when it comes to inflation targeting but is happy to support banks.
Against Economics – Book Review of “Money and Government: The Past and Future of Economics” (The New York Book Review) David Graeber argues that the mainstream economic thinking and policy is broken yet continues to be used. [Bearish economists!]
Learning and Misperception: Implications for Price-Level Targeting (Fed Board of Gov) Fed argues against adopting a temporary price-level targeting strategies during a recession. [Bearish rates]
The Global Equilibrium Real Interest Rate: Concepts, Estimates, and Challenges (Fed Board of Gov) Fed argues that they may have overestimated how high real rates should be as they didn’t correctly incorporate global trends. [Bullish rates]
Fed’s Push into Funding Markets Stirs Fears of Widening Role (Politico) Questions whether the FED’s latest effort to intervene in the funding market can lead to the Fed becoming the whole U.S. money market. The expectations that the FED will protect banks in volatile markets that are inconvenient to monetary policy, can potentially lead to adverse risk-taking by the banks. [Bullish banks]
Amidst Australia battling with catastrophic bushfires, the San Fran Fed is waking up to the need to tailor monetary policy to climate change and natural disasters. In Europe, the efforts to save the staling economy – and the euro – are surging.
A Phillips Curve for the Euro Area (Ball, Mazumder) Finds that the textbook Philips Curve largely holds for the Euro area, using a weighted median rather than core inflation rate, which includes food and energy prices.
Why Climate Change Matters for Monetary Policy and Financial Stability (Federal Reserve) After the Kincade fire in California destroyed homes and businesses alike and the ongoing Australian bushfires, monetary policymakers are waking up to the need for incorporating how disasters such as hurricanes, wildfires, and flooding affect labor markets, spending and output. [Bullish rates]
A Digital Euro to Save EMU (VOX EU) Thomas Mayer argues for the idea of relaunching the Euro as a digital bank central currency, suggesting it may be beneficial for the Eurozone economy in the long run and increase its competitive advantage on a global scale. [Bullish euro]
Yesterday, the Fed cut rates for the third time this year. The persistent low rate environment seems to be a cause of bubbles forming after all. The least central bankers can do is help reduce carbon emissions – ‘Green QE’ is all in.
When Yields Talk, Sectors Listen (Advisor Perspectives) Low interest rates impact not only bonds but equity valuations too. And some sectors are more rate sensitive. Financials suffer whereas Utilities, Consumer Staples, and Healthcare outperform. [Bullish these latter sectors]
Herd Behaviour in Asset Markets: The Role of Monetary Policy(VOX) Argues against economist Robert Shiller’s findings that bubbles are random and unpredictable and instead finds they are closely linked to loose monetary policy. [Bearish stocks]
Jens Weidmann: Climate Change and Central Banks(Jens Weidmann)Discusses ways in which central banks can be involved in transitioning to a low-carbon economy. Heavy focus on green finance or ‘Green QE’, however, might distract from the main policy objectives and hinder bank independence. [Bearish green bonds]
With a few new Central Bankers settling in, and the UK about to select its new Governor, the uncertainty around their next move remains. Earlier this week we discussed the few specific ways to make QE work, given it now seems inevitable – now we look at how politics might play with fiscal stimulus. We also feature a great analysis on why the Philips curve is still relevant and why the Fed should do all it takes to foster expansion.
Can Tariffs Have a Deflationary Impact? (The Library of Economics and Liberty) Not all tariffs are inflationary. Famously, the Depression-era Smoot-Hawley tariff reduced aggregate demand by enough to offset any inflationary impact. It contributed to causing the Great Depression. Bearish growth and equities.
Objectives and Boundaries of Monetary Policy: A Governor to Renew the Bank of England’s Monetary Vows (VOX) Warns thatthe credibility of central banks gained after decades of hard work could be unwound by a new era of economic populism. This could be accelerated by central banks issuing short-term debt to help the governments fund their spending sprees. Suggests yield curve steepening.
The Phillips Curve: Dead or Alive (VOX) Argues that the Philips curve, which links employment to inflation, is not dead as many believe but just in hibernation. It will wake up – this has happened before in the 1960s and history could repeat. Recommends the Fed’s to keep the economic expansion going, especially as unemployment could fall below natural rate estimates. Bulish rate markets.
Negative interest rates might be actually a good thing after all. Recent work by San Fran Fed shows they have stimulated economies.
The Cash Hoarding Puzzle and the Rising Global Demand for Cash (VOX) Demand for cash has been rising, despite the increased access to cashless payments.Finds monetary easing and aging population as main incentives for cash hoarding.
The Ownership of Central Banks (Bank Underground) Looks at the impact of public vs private ownership of Central Banks globally and finds that it makes little difference if the overarching aims are clear. Most, such as the BoE are wholly owned by the public sector, but in the US, Japan and Switzerland, there is a private shareholding.
Yield Curve Responses to Introducing Negative Policy Rates (San Francisco Fed) Studies the experience of five countries that introduced negative interest rates to see their impact on the economy. Finds that negative rates are effective in lowering yields of all maturities and effectively shifts the whole yield curve downwards, offering effective stimulus.
Worries are emerging around the nearing end of the cycle – and the possibility that the usual tools won’t work to revive it. More and more academic work is exploring unconventional policy and offers some comfort that it’s likely to work while policy-makers keep pushing for more easing.
Former Fed Chair Janet Yellen on Why the Answer to the Inflation Puzzle Matters (Brookings) Janet Yellen explains persistent low inflation and a flattened Philips Curve. She sees plenty of room for stimulating the economy and stoking wage gains without significant inflation.
Emergency Liquidity Injections (Reserve Bank of Australia) Compares the effectiveness of different methods of emergency liquidity injections in the banking system. Secured lending via repo seems best since it curbs fire sales and reduces incentive for liquidity risk-taking. Asset purchases aren’t as effective since banks aren’t required to commit future income as collateral.
Unconventional Monetary Policy Tools: A Cross-Country Analysis (BIS) Offers evidence that supports the use of unconventional monetary policy (negative rates, asset purchase programmes, forward guidance) in dealing with a downturn. Side effects such as overdependence on Central Bank funding and compressed rate margins are likely.
Everyone is worried about the structural challenges facing the Eurozone – it might be the eventual loser from the trade war. The US continues to face the “reserve currency curse” – the trade war could just be a mechanism to lose such status. It might just prove best to be a small economy, steer away from controversy and enjoy control over your policymaking.
Mario Draghi: Stabilisation Policies in a Monetary Union (BIS) Mario Draghi discusses whether the eurozone has increased its ability to stabilise macroeconomic shocks given that crisis has lasted in the region much longer than in other developed regions. The key matters are stabilisation across countries and stabilisation over the cycle.
Are Europe’s Economic Prospects Brighter Than They Appear?(Project Syndicate) Europe is the real loser from the US-China trade wars. The region is still extremely vulnerable to collateral damage, it always has the wrong policy response and is torn by internal political shocks (think Italy). Long-term prospects are brighter, however, driven by aggressive easing.
Nixon Shock, the Reserve Currency Curse, and a Pending Dollar Crisis(Mish Talk) The trade wars are just a hidden mechanism for the US to get rid of the “reserve currency curse”. No one seems to want to hold the World’s reserve currency and are working hard to ensure it stays that way. The EU and Japan have negative rates, China does not float the Yuan but props up corrupt SOEs, and Germany punishes the rest of the EU.
The Curse of Size (Econlib) Size matters – smaller countries have the choice to devalue their currency or go into negative rate territory without much attention and are free to control inflation. Argues that he creation of the euro made the world more susceptible to deflationary traps.
Unconventional Monetary Policy Operations: The Upside for Central Bank Balance Sheet Risks (Orduna, Schwaab) Finds that in exceptional circumstances, a central bank can remove illiquidity-related credit risk from parts of its balance sheet by extending the scale of its operations.
Threats to Central Bank Independence: High-Frequency Identification with Twitter (Bianchi, Kung, Kind) Academic paper finds that Trump tweets demanding the Fed cut rates does impact market pricing. Cumulatively, his tweets have lowered market expectations of Fed policy rate by 10bps.
Consumers Price Beliefs, Central Bank Communication, and Inflation Dynamics (Bank of Japan) Argues that prolonged periods of low inflation make the central bank’s inflation target less relevant for consumers. Instead, targeting price level (rather than the change in prices – inflation) would have more impact.
Credit Easing Versus Quantitative Easing: Evidence from Corporate and Government Bond Purchase Programs (Bank of England) BoE finds that buying corporate bonds was more effective than QE in reducing credit spreads, especially for higher-rated bonds.
Zero Lower Bound Risk according to Option Prices (San Fran Fed) Fed uses option prices and finds market has 24% probability that Fed policy rates will hit lower bound by end-2021.
New Weapons for the ECB (Project Syndicate) Former Greek finance minister, Yanis Varoufakis, argues that the ECB’s current toolkit will only lead to further right-wing populism as economic stagnation continues. Instead, he argues for the creation of “ECB conversion bonds” which effectively converts up to 60% of a country’s debt to low yielding bonds at ECB rates. This would allow for fiscal stimulus. Instead, he argues for the creation of “ECB conversion bonds” which effectively converts up to 60% of a country’s debt to low yielding bonds at ECB rates. This would allow for fiscal stimulus.
There’s so much criticism of monetary policy these days – much of it justified. One of the toughest criticisms is that it is leading to more monopolies. Aside from this, there is a role for more macro-pru policy and changes in the goals of policy.
Jerome Powell’s Dilemma (Project Syndicate) Top economists Carmen and Vincent argue that Powell is helping Trump get re-elected by neutralising the negative impacts of Trump’s trade policy.
Macroprudential Policy Could Have Reduced Imbalances in The Euro Area (VOX) Academics argue that country-specific macropru policy, such as adjusting LTV values for mortgages, are more affective in reducing Euro imbalances rather than ECB policy.
Could Ultra-Low Interest Rates Be Contractionary? (Project Syndicate) House of Debt authors Mian and Sufi and Princeton Prof Ernest Liu argue that big companies disportionately benefit from low rates and drive out competition. This reduces productivity and growth.
Hitting the Elusive Inflation Target (Chicago Fed) Argues that part of US’ inflation undershoot has been due to its symmetric inflation target. Allowing inflation overshoots is instead a better approach.
What Happens if Trump Tries to Fire Fed Chair Jerome Powell? (Brookings) It’s a bit more complicated than you think. Essentially, Trump would need cause (“inefficiency, neglect of duty, or malfeasance in office.) to remove him. Powell could sue if he felt it was unfair.
Did Dudley Do Right? (Project Syndicate) Prof Barry Eichengreen makes the case for the Fed and other central banks to make public their concerns about the policies of the government.
SNB – Between A Rock and a Hard Place (Pictet) Argues for more Swiss FX intervention to keep CHF weak, rather than rate cuts.
Central Banking’s Bankrupt Narrative (Project Syndicate, 4 min read) Prof Roger Farmer argues that aside from monetary policy not working, fiscal policy will also be ineffective. Instead, he argues that recessions are caused by asset market crashes and so policy should focus on that.
Estimating the economic impact of a wealth tax (Brookings, 3 min read) Makes the case for a wealth tax on the top 0.1% of Americans (see chart). Argues that it is more likely to work compared to other attempts in Europe which had a broader target. This is gathering support from various Democrat Presidential candidate.
Negative Interest Rates and Inflation Expectations in Japan (San Fran Fed, 8 min read) They find that inflation expectations actually fell after the BoJ introduced negative rates in 2016. They warn against cutting rates below zero.
Do Monetary Policy Announcements Shift Household Expectations? (Dallas Fed, working paper) They find Fed policy rate move surprises DO impact households’ economic confidence, but surprises on forward guidance and QE DO NOT. This questions the efficacy of unconventional policy.
ECB corporate QE and the loan supply to bank-dependent firms (ECB, working paper) – The central bank finds that corporate QE did increase bank lending. This suggests the ECB will restart such programmes soon.
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