Two experiments for the price of one

Today we saw not one, but two experiments on the impact of negative IOR on bank stocks.  In my previous post I pointed out that European bank stocks soared on a more expansionary than expected stimulus package from the ECB, including lower IOR and QE.

Shares in eurozone banks rallied sharply after the ECB announcement with Deutsche Bank up 6.5 per cent, Commerzbank up 4.9 per cent,Société Générale up 5.4 per cent and UniCredit up 8.2 per cent.

But how do we know that monetary stimulus helps the banks?  Maybe it was some other aspect of the package.  Fortunetely, we got another policy experiment soon after.  Again, here’s the FT:

The European Central Bank cut its benchmark interest rates to a new low and expanded its quantitative easing package, in a bolder-than-expected package aimed at boosting the eurozone’s flagging economy.

However, Mario Draghi, ECB president, played down the prospects of further rate cuts, swiftly reversing a sharp slide in the euro against the dollar.

They are talking about Draghi’s comments at the press conference afterwards, which suggested that further rate cuts were unlikely.  Big mistake.  And exactly as expected, European bank stocks fell on the contractionary announcement, wiping out the gains from earlier in the day.  You don’t get much better natural experiments than today.

I’ll say it again:  So do more!!



22 Responses to “Two experiments for the price of one”

  1. Gravatar of Jim S. Jim S.
    10. March 2016 at 10:48

    Off topic, but here are some quotes from Neil Irwin’s book “The Alchemists” when he is covering the Fed actions in late 2011 that I found interesting. From page 338:

    Bernanke had already assigned Fed economists to do an extensive study of how nominal GDP targeting might work, using computer models to examine its potential benefits and pitfalls. The FOMC listened to a detailed staff presentation and discussed the idea at length on the first day of its November 1-2 meeting. In theory, the idea had promise, the staff models suggested. But there were also great weaknesses to the approach. For instance, it would work only if the Fed could credibly deliver on its pledge over a very long time, perhaps ten of fifteen years.
    And following the policy would mean if growth remained slow, the Fed would not simply accept high inflation, but practically promise it.

    The discussion of nominal GDP targeting and variations thereof took up hours on that November Tuesday. Some FOMC members, particularly those on the central bank’s more hawkish wing, viewed it as not worth considering because they saw stable prices and low inflation as the most important goals of a central bank. They simply couldn’t abide a policy that would mean tolerating higher inflation. Others had a more nuanced set of views. But at the end of the discussion, not even any of the committee’s more dovish members was prepared to endorse such a policy.
    Bernanke himself, when speaking privately with colleagues about the topic, would become uncharacteristically animated and strident, apparently annoyed that economists who hadn’t analyzed the pros and cons of nominal GDP targeting as carefully as the Fed had would assert with such supreme confidence that it was the policy to pursue.

  2. Gravatar of ssumner ssumner
    10. March 2016 at 11:00

    Thanks Jim, I believe that if Bernanke had been one of those economists not at the Fed, he would have favored NGDP targeting.

  3. Gravatar of AL AL
    10. March 2016 at 11:22

    The curious thing here isn’t the market reaction to D’s comments, it’s why he made them in the first place.

    I’m reminded of that great MM explainer on FB you linked to awhile back, in which the incredulous central banker explains he’s really REALLY tried to boost the money supply, and can’t understand why he’s getting no response (all the while signaling he’s getting ready to fight inflation)…

  4. Gravatar of Rajat Rajat
    10. March 2016 at 12:37

    I’m sure you have addressed this before, Scott, but is there a point where negative rates encourage hoarding and become contractionary? In which case it could be better to switch back to QE combined with some sort of escalating rule to do more (eg doubling asset purchases each month) until the target looks like being met.

  5. Gravatar of ssumner ssumner
    10. March 2016 at 12:50

    Al, Good point.

    Rajat, You asked:

    “I’m sure you have addressed this before, Scott, but is there a point where negative rates encourage hoarding and become contractionary? In which case it could be better to switch back to QE combined with some sort of escalating rule to do more (eg doubling asset purchases each month) until the target looks like being met.”

    Just to be clear, I prefer QE to negative IOR. And I prefer NGDPLT to either of them.

    But as to your questions, I’m not certain. I seem to recall Nick Rowe doing something on that. The question is whether the increased demand for currency would more than offset the decreased demand for bank reserves. I kind of doubt it, but I can’t rule it out.

    It’s very tough to test empirically, because low IOR is correlated with low bond yields, and low bond yields are correlated with failed monetary policy. That’s why I rely on even studies.

  6. Gravatar of marcus nunes marcus nunes
    10. March 2016 at 13:06

    Scott, and many mistakenly see the “secondary” market movement as strong indication that the Fed is getting “impotent”!

  7. Gravatar of Britonomist Britonomist
    10. March 2016 at 14:32

    Actual headline of the day: “ECB stimulus surprise sends stock markets sliding”

    How weak must a stimulus measure be (perceived to be by the market) if it can be entirely nullified by an official sort of suggesting that they might not do much more after this any time soon.

  8. Gravatar of ssumner ssumner
    10. March 2016 at 15:28

    Marcus, Yes, get out of 1st gear—nice metaphor.

    Britonomist, Sometimes the media makes me want to pull my hair out. Is the BBC really that stupid, or do they have an agenda here? What do you think?

    As far as the initial stimulus, we know roughly how strong it was, the euro fell about a point and European stocks rose a couple percent. But Draghi’s forward guidance was (unfortunately) even more powerful.

  9. Gravatar of Benjamin Cole Benjamin Cole
    10. March 2016 at 15:39

    Good post. Central bankers almost invariably become monetary anorexics with an hysterical sqeamishness about inflation. Something about the role and culture. Also, central bankers are highly attuned to the needs of the finance industry.

  10. Gravatar of Ray Lopez Ray Lopez
    10. March 2016 at 20:07

    A well known Wall Street maxim is that a short, temporary but fundamentally unsound spike in prices can be due to a press release. Hence the derogatory comment “it’s worth only a press release”. A lesson Sumner still hasn’t learned.

  11. Gravatar of James Alexander James Alexander
    11. March 2016 at 03:34

    There is a lot of market positioning, ie short-term trades put on, ahead of these meetings so leading to sharp moves on surprises in the announcements and during the press conferences. Traders love the volatility, but also fear losing, obviously. You can thus get strange things happening. Draghi’s press conference stumbling wasn’t too bad, but bad enough to cause a lot of short-covering for people betting on a US$ rise vs the Euro, they were winning but then started to lose forcing a squeeze the other way. Today’s reaction in the markets shows yesterday’s mid-conference sell-off to have been one of these short-covering squeezes. Over the two days the European markets have responded well. All good fun in the end. NGDP growth in Europe should still be OK, but not as good as it could be if Draghi were able to change up a gear or three.

  12. Gravatar of Andy Andy
    11. March 2016 at 03:43

    I don’t understand how Draghi can be so naïve again (and again and again). He should have already by now known that it’s the forward guidance and hints of future policy markets care about, not some interest rate decimals.

    We need a Bernie Sanders type of character to head ECB.

  13. Gravatar of Dan W. Dan W.
    11. March 2016 at 05:24

    And now on day 2 it appears Draghi is the financial savior and no longer the goat. The James Alexander comment provides the best explanation of market dynamics and good caution to those who want to use short term market behavior to justify their economic interpretation.

  14. Gravatar of ssumner ssumner
    11. March 2016 at 05:30

    James, That’s possible. The reason I like the initial reaction best (which was positive) is that it best reflects the mindset of the markets. If prices soar on a surprise policy, we can be pretty sure the market views that policy as expansionary, even if later other facts come out that change the reaction.

    And of course we have many other such examples, which confirm what happened yesterday.

  15. Gravatar of Dan W. Dan W.
    11. March 2016 at 05:40


    The initial response to feeding children cookies and ice cream is euphoria. Yet a wise person would not conclude that always feeding children cookies and ice cream is a good plan. A plan of solving the perils of high debt with the creation of even more debt is not a solution, it is suicide. Just as it would be if children were fed cookies and ice cream every time they were hungry.

  16. Gravatar of ssumner ssumner
    11. March 2016 at 05:48

    Dan, Comparing event studies to feeding ice cream to a child!?!?!

    Wow, you really are over your head. At times you even make even Ray look smart by comparison.

    Might I suggest switching to commenting on a different type of blog, say gardening or sewing.

  17. Gravatar of Vaidas Urba Vaidas Urba
    11. March 2016 at 06:17


    Market reaction yesterday made me very uncomfortable, as the totality of day’s news was a clear positive – the decision was a clear landslide win for Draghi, and the ECB signaled they will do whatever it takes with QE, but the markets crashed. Here are some possible interpretations:

    1. Antonio Fatas ( ) and Miles Kimball are right that negative rates are the right tool rather than more QE. News that ZLB is closer than it appeared crashed the markets.

    2. Temporary coalition of ZLB-fearing Keynesian traders and monetary policy denialists had the upper hand yesterday

    3. Markets were not efficient yesterday due to technical factors or algobots

    4. Heightened tail risks to global economy mean that markets care less about what the ECB is actually doing, and it is more important how the ECB will react if negative scenarios materialize

    5. Draghi was very tired and this was the cause of miscommunication with the markets

    I put the most weight on a combination of 2 and 4.

  18. Gravatar of James Alexander James Alexander
    11. March 2016 at 09:13

    I’d say 5 was important too. It’s partly a language thing. English is not Draghi’s first language. It’s easy for English listeners to forget this fact with all sorts of non-native English speakers. You think someone has good English because they speak it well but it can be highly misleading, I often find. And when then non-native speaker is very tired, say after having had to argue with a gaggle of Germanic inflation hawks for two days, plus (not fully) mastering a lot of technical details for the new TLTROs and asset purchases, it’s understandable someone might slip up.

    The Timothy Lee piece that Scott links to is fair enough, but looks a bit silly now the market has had second thoughts today. I know Scott won’t like the “second thoughts” notion for market reaction but we are in new territory for markets and real-time reactions to complex stuff being explained during press conferences can be wrong. As we see today.

  19. Gravatar of Dan W. Dan W.
    11. March 2016 at 19:08


    The evidence that monetary easing boosts asset price is well established. It works every time it’s tried! Alas, like a sugar rush, the effects wear off. As this happens in the financial world everyone with skin in the wall street game clamors for more stimulus! The central bankers, like grumpy grandma, say no and asset prices being to fall. Headlines scream of financial doom, of recession and worse! Politicians challenge the bankers to justify their policies. And eventually grumpy grandma bends and she gives wall street another serving of ice cream.

    So the question that matters is not whether central bankers can manipulate the value of currencies, stocks and bonds. The question that responsible leaders would address is what next? How does this end?

    If the answer is always “more debt” then there will be an end to the game. It is just a matter of when economic forces call the central bankers bluff and the bankers are shown to be holding a busted hand.

  20. Gravatar of derivs derivs
    11. March 2016 at 19:54

    Dan W.
    It ain’t just bubblin brown sugar. Do you understand the concept of NPV and the effect of lower interest rates on discounting of forward cash flows?

  21. Gravatar of Gary Anderson Gary Anderson
    11. March 2016 at 23:31

    I know you said negative IOR good, negative interest rates bad. But isn’t it hard to have one without another? The ECB seems to have a lot of both.

  22. Gravatar of ssumner ssumner
    12. March 2016 at 14:09

    Vaidas, I think there are more straightforward interpretations, see my newer posts.

    Dan and Gary, Do you ever read the other commenters and wonder if you are in a bit over your heads?

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