Case closed

Last week, I pointed to a Financial Times headline that suggested the yen was falling on rumors of a cut in the interest rate on reserves (which is already negative):

In the long run, you want to rely on a worldview that allows you to make sense out of the myriad news events that are reported each day.  I believe that framework is market monetarism.  Let’s take an example, a headline from today’s FT:

Yen dives on talk of negative rates on loans

If you relied on the mainstream media, that headline would make no sense.  “Wait, weren’t we told on Twitter that Sumner was foolishly attached to the notion that negative IOR was expansionary, despite all indications to the contrary?  If so, how are we to understand this headline?”  On the other hand if you relied on market monetarism, there would be no cognitive dissonance to deal with.  It would all make perfect sense.

Tuesday, Tyler pointed to another FT story, this time claiming the exact opposite:

Ten weeks after BoJ governor Haruhiko Kuroda startled both financial markets and parliamentarians with Nirp, the yen has appreciated by some 8 per cent against the dollar. The stock market has rebounded sharply this month, however the Topix bank index remains 11 per cent lower since the advent of Nirp.

Under such a policy, risk assets were supposed to rise, but instead demand for Japanese government bonds rallied, rewarding the risk averse. Meanwhile, even finance ministry officials concede that the deflationary mindset is more entrenched than ever. There is agreement that Nirp has backfired and such an unsustainable monetary policy cannot support growth, let alone help financial asset prices.

Who to believe, the FT, or the FT?  Answer, the FT.  Today’s Financial Times provides the results of about as dramatic an event study as you could ever want:

Yen surges and stocks hit as BoJ stands pat

So much for the theory that negative IOR is contractionary.  And the concurrent fall in global stock markets puts another nail in the theory of “currency wars” and “beggar-thy-neighbor”.  The failure of the BOJ to devalue the yen is going to hurt the US and European economies.

Why so much confusion?  Because people forget that while a lower policy rate is expansionary on any given day, low rates are also an indication that money has been too tight.  This paradox is resolved if we make the (quite plausible) assumption that when the Wicksellian natural rate is falling, the policy rate usually tends to fall more slowly, making policy effectively tighter (as in 2008).  And when the Wicksellian rate is rising, the policy rate usually tends to rise more slowly, making policy effectively looser (as in the 1970s.)

It doesn’t take a genius to understand that you evaluate a policy’s effect by looking at the immediate market reaction, not market moves in the following weeks, which could be caused by 101 factors.  Oh wait, I guess it does take a genius.

Here’s a graph showing the fall in the yen last week on rumors of a rate cut, and the more than 3% gain today on the market disappointment at the BOJ’s inaction:

Screen Shot 2016-04-28 at 8.53.33 AMA few weeks ago, I did a post suggesting that the BOJ appears to be giving up on its 2% inflation target.  I suggested that this meeting would give us an answer:

What should Japan do?  I suppose they should do whatever they want to do.  It doesn’t make much sense to target inflation at 2% if you don’t want to target inflation at 2%.

The more interesting question is what should they want to do?  I’d say NGDPLT. But they seem to have other ideas.

Either way, we should have an answer by the end of the month.

Today we got the answer.  The FT also reports the following:

The BoJ also changed its guess of when inflation will reach 2 per cent from the “first half of fiscal 2017” to “fiscal 2017”. Any further delay would mean admitting Mr Kuroda will not reach the target during his term in office.

The whole point is to not adjust the forecast, but rather to adjust the policy instruments.  A very disappointing performance by Mr. Kuroda.  That’s not to say it couldn’t be worse, he has gotten Japan out of its nearly two-decade bout of deflation. But he’ll need to be far more aggressive at the July meeting if he doesn’t want to lose all credibility.  As it is, the BOJ lost a significant amount of credibility today.  Here’s Bloomberg:

A majority of economists surveyed by Bloomberg had predicted some action to counter a strengthening yen that had cast a shadow over the outlook for wage gains and investment spending. The explosion of volatility shows how investors have singled out central banks as the key driver for global financial markets.  .   .   .

“It’s the central banks that still set the course,” said Jan Von Gerich, chief strategist at Nordea Bank AB in Helsinki. “Even slight deviations from what people are expecting are enough to trigger market moves.” .   .   .

“The BOJ had an opportunity to at least temporarily short-circuit the yen trend but failed to act,” said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “It has provided the green light for further yen strength in the near-term.”



13 Responses to “Case closed”

  1. Gravatar of Effem Effem
    28. April 2016 at 05:19

    Case closed? US inflation expectations are up rather strongly today.

  2. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2016 at 05:27

    Haruhiko Kuroda has shown leadership by central banker standards, but evidently could not overcome the consensus of his board, which voted 8-1 or something like that in favor of this do-nothing policy.

    Something about central banking creates a culture extremely averse to monetary stimulus. No matter how long a depression or recession is extended, you will still read about central bankers fulminating against inflation and monetary debauchery.

    As many have pointed out, the US would still be in the Great Depression if it had been up to our central bankers.

  3. Gravatar of JP Koning JP Koning
    28. April 2016 at 07:11

    Japanese bond prices rose on the news. Any thoughts?

  4. Gravatar of Gary Anderson Gary Anderson
    28. April 2016 at 07:34

    Maybe they don’t want negative IOR, just negative bond yields to fund the government. What a scam!

    They could always do real helicopter money, which apparently Kocherlakota and Bernanke do not really understand to my dismay:

  5. Gravatar of ssumner ssumner
    28. April 2016 at 07:43

    Effem, How does that relate to the post?

    JP, Interesting. One of those cases where the Fisher effect seems to have outweighed the liquidity effect.

  6. Gravatar of flow5 flow5
    28. April 2016 at 08:26

    The bond market is a better barometer than the exchange rate.

    Alfred Marshall, the Cambridge economist, is responsible for developing the cash-balances approach to money. For example, if individuals collectively desire expanding their cash balances (increasing the period over whose transactions purchasing power in the form of money is held), they will initiate a chain of events which will lead to a net reduction in their aggregate holdings of cash.

    That is, an over-all increase in the demand for money leads to falling prices, a decline in profit expectations, reduced borrowing from the banks — and therefore a smaller volume of cash balances.

    Money thus is truly a paradox – by wanting more, the public ends up with less, and by wanting less, it ends up with more. All motives which induce the holding of a larger volume of money will tend to increase the demand for money – and reduce its velocity.

  7. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2016 at 09:40

    Former House Speaker John Boehner called Republican presidential candidate Ted Cruz “Lucifer in the flesh,” in a withering interview at Stanford University published Thursday.

    So we have Lucifer and Hitler in the running…and that’s just on the GOP side!

  8. Gravatar of Art Deco Art Deco
    28. April 2016 at 11:45

    Former House Speaker John Boehner called Republican presidential candidate Ted Cruz “Lucifer in the flesh,” in a withering interview at Stanford University published Thursday.

    Another piece of evidence, in case we needed one, that Capitol Hill is stupefyingly insular. The man described as ‘louche, alcoholic, and lazy’ by one insider (descriptors which have some specificity) offers venomous insults directed at a member of Congress whose offense was getting in the way of some s****y deal he was cooking up. Congress tolerated (in fact lionized) vehicular manslaughterer Ted Kennedy for five decades, was by all appearances willing to tolerate Rahm Emmanuel (a man with a history of screaming foul-mouthed insults 24/7, and a man of whom there’s a facial case that he’s taken eight-figure sums in bribes), tolerates Richard Shelby (he of the three-digit set of anonymous holds on nominees), tolerates Harry Reid (another cretin absurdly wealthy given that his private sector career consisted of nine years practicing law in a mid-sized city), tolerates Eleanor Holmes Wheresmybribe Norton, tolerates Maxine Offhermeds Waters, tolerates upChuck Schumer, tolerates Kristen Tracy Flick Gillibrand (lying her tuchus off about male college students of late), tolerated for three decades the absurd publicity hound Arlen Specter, tolerated greaser Al d’Amato…

  9. Gravatar of Gordon Gordon
    28. April 2016 at 12:48

    Scott, speaking of misinterpretations of monetary policy, I saw an interview with Joseph Stiglitz in The Atlantic. And one of the things he said made me figuratively face palm:

    “Lowering the interest from 5 percent to 0 didn’t bring a robust recovery. Lowering it from 0 to minus 1/2 percent isn’t going to do it either.”

    This makes me wonder just how many economists are unaware that much of the lowering of the fed funds rate was retroactive rather than proactive as you’ve pointed out here. Or that the proactive cut in the fed funds rates was offset by IOR. The full article is at

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    28. April 2016 at 14:47

    Scott’s new colleagues at Mercatus have something relevant;

    ‘With the model’s parameters fitted to real data, we confidently conduct counterfactual experiments on alternative regulatory environments. Our results show that economic growth has been dampened by approximately 0.8 percent per annum since 1980. Had regulation been held constant at levels observed in 1980, our model predicts that the economy would have been nearly 25 percent larger by 2012 (i.e., regulatory growth since 1980 cost GDP $4 trillion in 2012, or about $13,000 per capita).’

    .8 per cent when growth is only 1.2% seems like a pretty big deal.

  11. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2016 at 18:28

    Patrick Sullivan–

    Sheesh, we could see 5+% real growth in the California economy for years and years with just two regulatory changes: No property zoning and decriminalize push-cart vending.

    Newport Beach would become “Miami Beach West On Steroids”!

    It would be Boom Times in Fat City.

    But local property owners do not want it. It is a pinko-nirvana down there in Orange County. They believe in socialist property controls, as determined by the community.

    And no one wants a 50-story condo tower, ground-floor retail, next too their single-family detached home.

  12. Gravatar of Benjamin Cole Benjamin Cole
    28. April 2016 at 19:09

    Art Deco, re Cruz.

    Well, Ted Cruz has many times said his campaign is divinely inspired and underwritten.

    Boehner is only suggesting which divinity is involved.

  13. Gravatar of ssumner ssumner
    29. April 2016 at 16:08

    Gordon, Unfortunately there are many economists who don’t know the difference between interest rates and monetary policy.

    Patrick, Thanks, that sounds interesting.

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