Commenter SDOO sent me the following:
Kocherlakota quoted you on Twitter re: Fed, ECB, BoE and BOJ getting together next week.
That’s quite an honor. Stephen Kirchner sent me a couple of FT articles. The first contains some extremely interesting information on the zero lower bound, which is looking less and less like a lower bound:
But the Bank of Japan’s set-up for negative rates, which apparently follows the Swiss National Bank’s, casts doubt on the premise that the nominal cost of holding cash is zero. As we have explained, if a private Japanese bank wishes to exchange its central bank reserves for cash, the BoJ will adjust the portion of its reserves to which negative rates apply by the same amount. That means any extra cash that a bank wishes to hold will cost it as much as if it kept it on deposit at the central bank.
But what really matters is what the public wants to do. JP Koning nicely explains the “hot potato effect” of pushing central bank reserve rates below zero: banks will bid down rates on other assets in the financial system as they try to swap reserves for cash. Ultimately, they will be forced to lower rates on deposits below zero as well, so that customers will have to pay to keep their money on deposit. This is where the liquidity trap is really supposed to snap shut: will there not be a run for cash as depositors refuse to pay banks to hold their money?
But consider two things. First, it is not as if depositors as a class actually have a legal right to convert all their money to cash as it is. You cannot present a debit card at the Bank of England and demand cash. Indeed, even your own bank limits how much cash you can withdraw, as Frances Coppola has pointed out. Just read the fine print of your account terms of service.
And how could private banks honour mass withdrawals of cash even if they wanted to? No law provides for the central bank to swap client deposits for cash; only central bank reserves. And despite the huge growth of reserves in recent years, these still amount to only a fraction (about one-fifth in the UK) of bank deposits. So, to honour customers’ demands, banks would have to borrow more reserves from the central bank, which could impose terms as onerous as it wished. Onerous enough that banks would try to pass the cost on to customers. As my colleague Richard Milne argues in an analysis of Danske Bank’s success — its market value now exceeds that of Deutsche Bank — Danske is thriving because it has adapted to Denmark’s negative rates, in part by indeed passing them on to customers.
Second, the BoJ’s and SNB’s set-ups to neutralise banks’ incentive to hold cash instead of reserves can be exactly duplicated by the banks themselves vis-à-vis their customers. You want to take cash out of your account? Be our guest, but we will keep track of your total balance of net cash withdrawn and charge you the same interest on that balance as we charge on your deposits. This can be implemented through one of the regular “updated terms and conditions” that our banks seem to impose on us unilaterally every so often.
Read the whole thing. This article (by Martin Sandbu) confirms my claim back in 2009 that the central bank could impose negative IOR on vault cash, but it also provides lots of options that I never contemplated. More evidence that central banks never really tried very hard, which is obvious now that the Fed is no longer at the zero bound (and should have been obvious during 2008-12 when the ECB was above the zero bound.)
The second FT article is an odd one, with some good stuff:
December 16 2015 may go down as the date of one of the most monumental policy errors in history. The financial markets were nervously anticipating that the US Federal Reserve would raise the interest rate for the first time in nearly a decade — but few grasped the inadequacy of the data driving the decision.
The Fed had never before initiated a tightening cycle when the manufacturing sector was shrinking. . . .
The bond market, meanwhile, sees no shades of grey in the data; it is shifting rapidly from pricing in one rate hike this year towards pricing in the possibility of the next move being a rate cut, all but ridiculing the Fed’s insistence that four rate hikes would come to pass in 2016.
Tellingly, Fed officials are softening their tone on the number of times the rate might rise this year. “Don’t fight the Fed” — the idea that markets ultimately benefit from the Fed’s decisions — has become a cliché. The truth is the Fed has never dared fight the markets.
There’s that term ‘dare’ again, which Tyler Cowen mentioned a few weeks back (and I quoted in a recent post.) Unfortunately this generally good article (by Danielle DiMartino Booth) is marred by one dubious claim:
With hindsight, few dispute that the Fed missed an opportunity to raise rates in 2014. No doubt, tightening policy at that stage would have created its own messy side-effects. That said, the benefits would have been significant.
First, for example, commodity prices might not have risen so high or so fast without the cheap money flowing from the US to emerging markets. Property prices worldwide might not be as frothy had investors not sought refuge in the sector from what they rightly recognised as risky valuations in equity and bond markets. And “fragile” would not now be the word for financial markets and economies worldwide.
Is it really true that “few” dispute this claim? I certainly do. I’m not saying it’s impossible, counterfactuals are always tricky, but it certainly should not represent the conventional wisdom at this point, unless I’m missing something.
BTW, Just to be clear I am currently much more worried about NGDP growth than jobs. I still think a recession is unlikely for the US in 2016. Rather I worry that if NGDP growth and long-term rates stay low, the Fed will be ill-prepared for the next recession—unless it shifts to NGDPLT. And let’s face it; no one can predict recessions.
PS. I have a new article in The Fiscal Times discussing my Depression book, and its implications for current policy debates.
PPS. Over at Econlog I have a new post on a talk given by James Bullard.
PPPS. I will be giving a couple talks at the Warwick Economics Summit this weekend, so my blogging may tail off for a few days.