Main characteristics of unconventional measures (3)

KEYNOTE LECTURE AT THE INTERNATIONAL CENTER FOR MONETARY AND BANKING STUDIES (ICMB),
GENEVA, 28 APRIL 2009

 

Main characteristics of unconventional measures

When conventional tools can no longer achieve the central bank’s objective, policy-makers are confronted with a number of issues.

• First, the unconventional tools include a broad range of measures aimed at easing financing conditions. Having this menu of possible measures at their disposal – which are not mutually exclusive ones – monetary policy-makers have to clearly define the intermediate objectives of their unconventional policies. These may range from providing additional central bank liquidity to banks to directly targeting liquidity shortages and credit spreads in certain market segments. The policy-makers then have to select measures that best suit those objectives.
• Second, they should be wary of the possible side-effects of unconventional measures and, in particular, of any impact on the financial soundness of the central bank’s balance sheet and of preventing a return to a normal market functioning.

In general, unconventional measures can be defined as those policies that directly target the cost and availability of external finance to banks, households and non-financial companies. These sources of finance can be in the form of central bank liquidity, loans, fixed-income securities or equity. Since the cost of external finance is generally at a premium over the short-term interbank rate on which monetary policy normally leverages, unconventional measures may be seen as an attempt to reduce the spreads between various forms of external finance, thereby affecting asset prices and the flow of funds in the economy. Moreover, since these measures aim to affect financing conditions, their design has to take into account the financial structure of the economy, in particular the structure of the flow of funds. Let me elaborate on the possible measures.

One way to affect the cost of credit would be to influence real long-term interest rates by impacting on market expectations. Expectations may work through several channels. For instance, the central bank can lower the real interest rate if it can induce the public to expect a higher price level in the future.  If expected inflation increases, the real interest rate falls, even if the nominal interest rate remains unchanged at the lower bound. Alternatively, policy-makers can directly influence expectations about future interest rates by resorting to a conditional commitment to maintain policy rates at the lower bound for a significant period of time.  Since long-term rates are prima facie averages of expected short-term rates, the expectation channel would tend to flatten the entire yield curve when policy-makers commit to stay at the lower bound. Moreover, a conditional commitment to keep the very short-term rate at the lower bound for long enough should also prevent inflation expectations from falling, which would otherwise raise real interest rates and curtail spending. In either case, if the management of expectations is successful, it would – ceteris paribus – reduce the real long term rate and hence foster borrowing and aggregate demand.

Another way in which the central bank can influence the cost of credit is by affecting market conditions of assets at various maturities – for instance, government bonds, corporate debt, commercial paper or foreign assets. Two different types of policies can be considered. The first aims at affecting the level of the longer term interest rate of financial assets across the board, independently of their risk. Such type of policy would operate mainly by affecting the market for risk free assets, typically government bonds. This policy is typically known as ‘quantitative easing’. The second policy is to affect the risk spread across assets, between those whose markets are particularly impaired and those that are more functioning. Such a policy would be usually referred as ‘credit easing’. The two types of policies affect differently the composition of the central bank’s balance sheet.  Another difference is that ‘credit easing’ can generally be conducted also at above-zero levels of the short-term nominal interest rate, while quantitative easing should make sense only when the interest rate is at zero or very close to zero. However, both operations aim at increasing the size of the central bank balance sheet and therefore expanding its monetary liabilities.

Let me now consider quantitative easing and credit easing in turn.

A World Awash In Liquidity

Whitney Tilson’s email to investors 

3) One of the reasons I'm bullish over a one-year horizon is that many macro factors are highly favorable. Here is an excerpt on this from part two of my report: "The Five Reasons We're Bullish on Stocks Right Now":

• To be clear... we're surely already in a recession and the damage is already significant.
• But our economy is gigantic and was doing quite well on the eve of this crisis...
• American households have the least leverage since 1984 (measured by total liabilities divided by total assets)...
• Interest rates are at all-time lows, providing unprecedented monetary stimulus...
• It looks like Congress will soon pass a $2 trillion stimulus bill that President Donald Trump has promised to immediately sign into law, which will provide unprecedented fiscal stimulus. And if that proves insufficient, the government can easily borrow trillions more at minimal rates...

The Federal Reserve has dusted off the playbook it implemented during the global financial crisis and is injecting massive amounts of liquidity into the financial system. In particular, the stimulus bill includes $454 billion in funds for the Treasury to backstop emergency actions by the Fed. Since every dollar from the Treasury can stand behind $10 lent by the Fed, this translates into $4.5 trillion to keep credit flowing and make direct loans to U.S. businesses, in effect doubling the Fed's current $4.7 trillion balance sheet...

And don't forget that Trump views a recovery in stock prices as critical to his reelection hopes.

4) As further evidence that we're in a world awash in liquidity, see this chart that Compound Capital Advisors CEO Charlie Bilello tweeted:

https://www.valuewalk.com/2020/03/ackmans-greatest-trade/

Negative interest rates are radical measures. What are negative interest rates? Why do banks impose negative interest rates? Does it work?

When interest rates are negative, this usual relationship is reversed, and lenders have to pay to lend money or to invest.

The general idea of imposing negative rates is to discourage people or organisations from certain investments.

Why do banks impose negative interest rates?

In short, for different reasons, but usually to try to stabilise the economy in some way:

• The Swiss National Bank brought in a negative rate to try to lower the value of the Swiss franc, which has been rising as people look for safer investments.
• The European Central Bank (ECB) imposed a negative interest rate to try to stop banks from depositing money with it, and instead lend to eurozone businesses.

Does it work?

Negative interest rates are rarely brought in, and are seen as quite a radical measure.

While negative interest rates are normally aimed at institutional investors, in the long term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.

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What are negative interest rates?

Tom EspinerBusiness reporter18 December 2014

• rom the sectionBusiness

Switzerland's National Bank (SNB) is to impose an interest rate of minus 0.25% on large amounts of money deposited in the country.

The negative rate will apply to "sight deposits" - a type of instant access account for banks and large companies - of more than 10m Swiss francs (£6.5m).

But why would a bank want to cut the value of deposits it holds, or charge depositors?

Image captionSwiss National Bank wanted to lower the value of the Swiss franc

What are negative interest rates?

Normally borrowers pay lenders a rate, typically as an annual percentage, on the amount borrowed.

So, for example, when people deposit money in a bank, they normally expect to get back some form of interest on the account.

However, when interest rates are negative, this relationship is reversed, and lenders have to pay to lend money or to invest.

The general idea of imposing negative rates is to discourage people or organisations from certain investments.

Image captionRussians have seen the value of the rouble fall by around a half since the beginning of the year

Why do banks impose negative interest rates?

In short, for different reasons, but usually to try to stabilise the economy in some way.

The Swiss National Bank brought in a negative rate to try to lower the value of the Swiss franc, which has been rising as people look for safer investments.

Factors such as a sharp drop in the value of the Russian rouble and steeply falling oil prices have spooked investors.

Switzerland normally sees money flowing into its coffers in difficult economic times.

However, if the currency is too strong, this can hit exports, as products become more expensive.

In June, the European Central Bank (ECB) imposed a negative interest rate, but for different reasons.

It wanted to try to stop banks from depositing money with it, and instead lend to eurozone businesses.

Image captionThe ECB remains under pressure to act to kick-start the eurozone economy

Does it work?

How effective negative rates are depends on many different variables.

In the case of Switzerland, the immediate impact was a temporary fall in the franc against the euro, but the currency was trading slightly higher by late morning.

Its longer-term impact remains to be seen.

The ECB's negative interest rate was announced as part of a raft of measures designed to stimulate the eurozone economy, which continues to stagnate.

Are we going to see more of it?

It very much depends on what banks want to achieve, and whether they think it's going to work.

Negative interest rates are rarely brought in, and are seen as quite a radical measure.

While negative interest rates are normally aimed at institutional investors, in the long term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.

Besides, central banks have a range of other measures available to them to stimulate the economy.

For example, since the global financial crisis, both the Bank of England and the Federal Reserve have used so-called "quantitative easing" - buying assets to boost the supply of money - as an economic stimulus.

The Bank of England considered imposing a negative bank rate in February 2013, but decided against it in May of that year.

However, it said at the time that negative interest rates remained an option.

With the global economy still fragile, negative rates remain a tool that banks could use.

http://www.bbc.com/news/world-europe-30530534

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https://www.techimo.com/forum/imo-community/313590-negative-interest-rates-today-boj.html

The Bank of Japan surprised markets Jan. 29 by adopting a negative interest-rate strategy. The move came 1 1/2 years after the European Central Bank became the first major central bank to venture below zero. With the fallout limited so far, policy makers are more willing to accept sub-zero rates. The ECB cut a key rate further into negative territory Dec. 3, even though President Mario Draghi earlier said it had hit the “lower bound.” It now charges banks 0.3 percent to hold their cash overnight. Sweden also has negative rates, Denmark used them to protect its currency’s peg to the euro and Switzerland moved its deposit rate below zero for the first time since the 1970s. 

Since central banks provide a benchmark for all borrowing costs, negative rates spread to a range of fixed-income securities. By the end of 2015, about a third of the debt issued by euro zone governments had negative yields. That means investors holding to maturity won’t get all their money back. Banks have been reluctant to pass on negative rates for fear of losing customers, though Julius Baer began to charge large depositors.

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https://www.techimo.com/forum/imo-community/313590-negative-interest-rates-today-boj.html

TOKYO — The Bank of Japan said Friday that it would adopt a negative interest rate policy for the first time, as a sputtering economy, stubbornly low inflation and turbulent global financial markets threaten to undermine Prime Minister Shinzo Abe’s economic-revival plan.

The central bank said it cut the deposit rate it pays on cash parked at the BOJ by commercial banks in excess of legally required reserves, to minus 0.1% from the previous plus 0.1%. The goal was to push down borrowing costs across a broad time spectrum to stimulate inflation, the bank said.

The bank decided to introduce negative rates to “pre-empt the manifestation of [downside] risk and to maintain momentum to achieve the price stability target of 2%,” the BOJ said in a statement released after a two-day policy meeting.
“We will cut the interest further into negative territory if judged as necessary,” the central bank said.
The vote count was 5-4 in favor of negative interest rates.

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Could Negative Interest Rates Arrive In America? The Collapse Of Cash

Could Negative Interest Rates Arrive In America?

They already have. Beginning on May 1st, JP Morgan Chase has announced they will charge certain customers a “balance sheet utilization fee” of 1% a year on deposits in excess of the money they need for operations. That amounts to a negative interest rate on deposits. Banks formerly competed for your money--now they want to charge you to park it with them.  

With interest on deposits at next to nothing, or now slightly negative, the only reason for consumers to keep money in the bank is convenience. The more money you lose money on your deposits in the form of a “utilization fee”, the more attractive your mattress becomes. But, as long as paper money and your mattress are available, the Fed will not be able to fully implement its negative rate policy in its quest to create inflation. After all, there would be a global run on the banking system if rates were to fall into negative territory by more than just a few percentage points.

So how can central banks and governments ensure rapid money supply growth and velocity if consumers have the option to hoard cash? Some of the “best minds” in Keynesian thought, like Kenneth Rogoff, have a solution to this. They are floating the idea that paper money should be made illegal and the evidence shows governments are listening. If you outlaw hard cash, and make all money digital, there is no limit to how much borrowers can get paid to borrow and how much savers get charged to save. This would make it unprofitable to hoard cash, and compel people to consume and borrow electronic currency as fast as possible. Money in the bank would become the “hot potato”: as soon as it hits your bank account the race would be on to move it to the next person’s account.  Whoever gets stuck with the money when the music ends pays a fee; that would be some increase in velocity!  And vastly negative real interest rates would force the amount of leverage in the economy to explode.

This idea sounds fairly Orwellian–allowing central banks to control every aspect of monetary exchange and giving the Federal Government an electronic gateway to every financial transaction. But when you think about it, the idea of a fiat currency and the Federal Reserve were radical ideas before they became common place. Indeed, this is exactly why the authors of our constitution tried to ensure gold and silver would have the final and only say in the supply and value of money.

Just as gold once stood in the way of governments' desire to expand the money supply, physical cash is now deemed as a fetter to the complete control of savings and wealth by the state. History is replete with examples of just how far governments will go to usurp control of people under the guise of the greater good. Sadly, the future will bring the collapse of cash through its illicit status, which will in turn assist in the collapse of the purchasing power of the middle class. Wise investors would take advantage of the opportunity to park their savings in real money (physical gold and silver) while they still have a chance.  

http://www.talkmarkets.com/content/us-markets/the-collapse-of-cash?post=64180


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We are in our seventh year of record-low interest rates and banks have been flooded with reserves. However, the developed world appears to be debt disabled. That is, already saturated in debt, therefore unwilling and unable to service new debt due to a lack of real income growth.

So the problem for central banks and governments is how to get the money supply booming in an environment where consumers want to deleverage and save. Zero percent interest rates (ZIRP) are inflationary and negative real interest rates foment asset bubbles and encourage new debt accumulation. For decades central banks have used their control of the price of money to coerce boom cycles that eventually turn to bust. But for the past six years, their foray into ZIRP land hasn’t provided the boom cycle they were expecting. Sure, they have created massive bubbles in bonds and equities--but the economy has yet to enjoy the promised growth that is supposed to trickle down from creating these bubbles.  They have set the markets up for a bust, yet the economy never enjoyed the boom. 

This has left Keynesians scratching their respective heads and scheming new ways to encourage even more borrowing and spending. The Keynesians who rule the economy now control the price of money but are having difficulty controlling its supply and producing rapid inflation rates.

Bank deposits that pay nothing and ultra-low borrowing costs haven’t proved effective in boosting money supply and velocity growth. The growth rate of M3 has fallen from 9% in 2012, to under 4% today. And monetary velocity has steadily declined since the Great Recession began. Therefore, unfortunately, the next baneful government scheme is to push interest rates much further into negative territory in real terms; and also in nominal terms as well! 

You would think this is absolutely absurd but it is already happening. The European Central Bank, has a deposit rate of minus 0.2 percent and the Swiss National Bank, has a deposit rate of minus 0.75 percent. On April 21st the cost for banks to borrow from each other in euros (the euro interbank offered rate, or Euribor) tipped negative for the first time. And as of April 17th, bonds comprising 31% of the value of the Bloomberg Eurozone Sovereign Bond Index, were trading with negative yields.

The real losers from lower rates Ironically, buying shares is one way of benefiting from lower interest rates.

For almost two years now investors have been taking out more mortgages than first home buyers.

When the Reserve Bank of Australia cut interest rates last week, we saw the traditional fanfare over winners and losers from the decision.

For the couple paying off a mortgage on a house they bought ten or twenty years ago, it was all upside. A lower rate reduces those interest payments and puts upward pressure on house prices, making them richer on paper and - due to lower interest payments - quite immediately boosts their spending money (or means they can pay off that loan more quickly).

On the other hand, retirees living in their own home off the income from term deposits, are seen as the victims. Lifelong savers, these people have too much cash to deserve the pension, but can't afford to live off the interest. Worryingly, they are eating into their principle. They are the first to receive our sympathy.

That's fair enough, but we hear a less about the impact on young adults. Still studying, or at the beginning of their careers, they are saving for a house deposit, often with a partner or spouse. The only problem is, their savings don't earn more than 3% in the bank, and - even putting aside a generous portion of their moderate pay package - house prices seem to outstrip even their best efforts at saving. 

House prices across the 5 largest capital cities are up 8% in the last year. Sydney has seen faster growth, with prices up 14.2% in the last 12 months, according to data from CoreLogic. There's little doubt this growth has been assisted by successive interest rate cuts. As a result, many young couples working in east coast cities, hoping to build their own nest, face little prospect of success in that regard. At least, not without some help from Mum and Dad.

Unfortunately, this leads to inequitable outcomes. Since support from Mum and Dad is now important in getting into to property, young couples who don't get that help are faced with significant hurdles to home ownership. This is particularly true in Sydney or Melbourne.

Adding insult to injury, some say that lower interest rates are to their advantage. After all, they are told, now they can afford to borrow more money. While true, this fact is hardly good news. It isn't just first home buyers who can afford to borrow more. It's everyone, including investors. And those same investors also benefit from the tax break afforded by negative gearing. 

Indeed, for almost two years now investors have been taking out more mortgages than first home buyers. For the entirety of 2015, first home buyers have accounted for less than a third of new Australian mortgages, according to data from the Australian Finance Group. That's a strong indication that investors are crowding first home buyers out of the market. 

Are there better options?

With record low interest rates offering a paltry return on savings, it is increasingly attractive for would-be first home buyers to postpone that ambition and invest in shares instead. With shares in high quality companies yielding considerably more than term deposits, the benefits of compounding are not out of their reach.

In fact, sharemarket investing is one area where a younger generation may have an advantage because statistics demonstrate that the length of time owning shares is one of the most reliable indicators of overall returns. With relative youth comes a relatively long time horizon during which a high quality business with honest and competent managers can generate value for its shareholders.

Foolish takeaway

Ironically, buying shares is one way of benefiting from lower interest rates. By investing in a sensibly diversified portfolio of shares, a young couple can position themselves to benefit from lower interest rates without taking out a 30 year loan. While it's no replacement for owning their own home (which is, after all, where the heart is) it may well be the most prudent decision. After all, a recent study from New York University found Sydney housing to be the third-least affordable in the world, with Melbourne not far behind at sixth.

http://www.smh.com.au/business/motley-fool/motley-fool-the-real-losers-from-lower-rates-20150511-ggyqca.html

Soaring bond yields across the world threaten trillion of dollars in losses for investors and a fresh financial crisis.

BIS fears fresh bank crisis from global bond spike

Soaring bond yields across the world threaten trillion of dollars in losses for investors and a fresh financial crisis unless banks are braced for the shock, the Bank for International Settlements has warned.

By Ambrose Evans-Pritchard

8:02PM BST 23 Jun 2013

The Swiss-based institution said losses on US Treasury securities alone will reach $1 trillion if average yields rise by 300 basis points, with even greater damage in a string of other countries. The loss could range from 15pc to 35pc of GDP in France, Italy, Japan, and the UK. “Such a big upward move can happen relatively fast,” said the BIS in its annual report, citing the 1994 bond crash.

“Someone must ultimately hold the interest rate risk. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.”

The warning comes after US Federal Reserve set off the most dramatic spike in US borrowing costs for over a decade last week with talk of early exit from quantitative easing (QE), sending tremors through the global system.

The yield on 10-year Treasuries has jumped 80 basis points since the Fed began to talk tough two months ago, closing at 2.51pc on Friday.

The side-effect has been a run on emerging markets, a reversal of hot-money inflows into China, and fresh debt jitters in Portugal, Spain, and Italy. Nomura said the US yield spike threatens to “expose the cracks in Europe once again” and short-circuit the US housing recovery.

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The BIS, the lair of central bankers, said authorities must press ahead with monetary tightening regardless of bond worries, warning that QE and zero rates are already doing more harm than good. The longer they go on, the greater the dangers.

“Central banks cannot do more without compounding the risks they have already created,” it said in what amounts to an full assault on the credibility of ultra-stimulus policies.

Describing monetary policy as “very accommodative globally” , it warned that the “cost-benefit balance is inexorably becoming less and less favourable.”

The BIS appeared call for combined monetary and fiscal tightening, prompting angry warnings from economists around the world that this risks a second leg of the crisis and perhaps a slide into depression.

“It is a resurgence of extreme 1930s liquidationism. If applied this would do grave damage to the world economy,” he said.

Marcus Nunes from the Fundação Getúlio Vargas in São Paulo said the report “reeks of Austrianism”, referring to the hard-line view of the Austrian School that debt busts lead to `creative destruction’ and should be allowed to run their course.

Prof Nunes fears a repeat of 1937 when premature tightening aborted recovery from the depression. “What is implicitly proposed is a degree of fiscal and monetary contraction that would make 1937 feel like a ‘walk in the park on a sunny day’.

The BIS said monetary stimulus has created a host of problems, including “aggressive risk-taking”, “the build-up of financial imbalances”, and further “misallocation of capital”.

It said the central bank mantra of doing “whatever it takes” to boost growth has outlived its usefulness, and has left the Fed, the Bank of England, and others, stuck with $10 trillion in bonds. “Central banks cannot repair the balance sheets of households and financial institutions. Central banks cannot ensure the sustainability of fiscal finances,” it said.

The emergencies policies have bought time for governments to put their budgets in order and tackle the deeper crisis of falling productivity, but this has been squandered. The BIS said leaders have put off the reforms needed to clear out dead wood and unleash fresh energy. Productivity growth in the rich states has dropped from 1.8pc between 1980-2000, to 1.3pc from 2001-2007, to just 0.7pc from 2010-2012. It has turned negative in Britain and Italy.

“Extending monetary stimulus is taking the pressure off those who need to act. In the end, only a forceful programme of repair and reform will return economies to strong and sustainable real growth,” it said.

Piling on the pressure, the BIS said to call for draconian fiscal tightening to avert a future debt crisis across the big industrial economies, with Britain needing to slash its `primary budget’ by up to 13pc of GDP to meet ageing costs.

“Public debt in most advanced economies has reached unprecedented levels in peacetime. Even worse, official debt statistics understate the true scale of fiscal problems. The belief that governments do not face a solvency constraint is a dangerous illusion. Bond investors can and do punish governments hard and fast.”

“Governments must redouble their efforts to ensure that their fiscal trajectories are sustainable. Growth will simply not be high enough on its own. Postponing the pain carries the risk of forcing consolidation under stress – which is the current situation in a number of countries in southern Europe.”

The call for double-barrelled fiscal and monetary contraction is remarkable, challenging the widely-held view that easy money is crucial to smooth the way for budget cuts and deep reform.

The BIS is in stark conflict with the International Monetary Fund and most Anglo-Saxon, French, and many Asian economists, as well as the team of premier Shinzo Abe in Japan. What is emerging is a bitter dispute over the thrust of global economic policy at a crucial moment.

Critics say the BIS is discrediting monetary remedies before it is clear whether the West is safely out of the woods. It may now be much harder to push through fresh QE if it turns out that the Fed has jumped the gun with talk of early bond tapering.

Scott Sumner from Bentley University said the BIS is wrong to argue that delaying exit from QE and zero rates is itself dangerous. The historical record from the US in 1937, Japan in 2000, and other cases, is that acting too soon can lead to a serious economic relapse. When the US did delay in 1951, the damage was minor and easily contained.

Prof Sumner warned that Europe risks following Japan into a deflationary slump if it takes the advice of the BIS and persists with its current contraction policies.

WATCH: Chris Bowie tells Emma Wall "the bond crisis could have already begun"

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/10138033/BIS-fears-fresh-bank-crisis-from-global-bond-spike.html