August 31, 2009
Riksbank's negative interest rate experiment...
Effective 8-Jul-09 Riksbank pays -0.25% on deposits!
As per the Minutes of the Executive Board’s monetary policy meeting on 1 July 2009:
"...Deputy Governor Lars E.O. Svensson began the discussion by pointing out that with regard to the lower limit for the repo rate there is a need to differentiate between what is possible and what is desirable from a monetary policy point of view. In the discussion about how far it is possible to lower the interest rate, something of a zero interest rate mystique has arisen which has exaggerated the problems relating to a zero interest rate. The zero interest rate bound does not apply to financial markets; they can handle negative interest rates if necessary. It is the relative prices between financial assets that matter. Interest rates are only one way of expressing relative prices; the price today of kronor tomorrow. If we take a 12-month treasury bill of a nominal value of SEK 100 000, there is no fundamental difference if today it has a price of SEK 99 000, 100 000 or 101 000, which would mean nominal interest rates of approximately 1, 0 or -1 per cent. In other words, there is nothing strange about negative interest rates. Moreover, it is real interest rates and not nominal interest rates that are important when making economic decisions. With an inflation rate of 2 per cent, the real price of 100 000 real kronor in the example above will be SEK 101 000, 102 000 and 103 000, that is the real interest rate will be -1, -2 or -3 per cent. The banks can also use charges to introduce what in reality are negative interest rates on transactional accounts.
The only reason why the concept of a zero interest rate has attracted so much attention is that there are banknotes. Banknotes yield zero interest. If households, companies and investors think that the rate of interest on their accounts is too low they can withdraw cash from these accounts and instead keep large amounts of banknotes in their safes, suitcases and closets. However, taking the handling costs into account, including crime-prevention measures, storage costs and so on, banknotes provide an actual yield that corresponds to a negative interest rate. The lower limit for the interest rate is thus not dependent on the financial markets but is determined by the interest rate at which households, companies and investors would begin to hoard large volumes of cash in the form of banknotes. It is probable that the interest rate could become negative before this happened, but we can not be certain where the lower limit lies. It is, however, possible to draw the conclusion that a policy rate of zero per cent would not necessarily entail any significant problems, especially in the light of experience in Japan, where the policy rate has been 0 and is now 0.1 per cent, in Switzerland, which has a target for the three-month Libor rate of 0.25 per cent and a repo rate of 0.05 per cent, and in the USA, where the federal funds rate is restricted to the interval between 0 and 0.25 per cent.
With regard to the interest rate level that is desirable from the monetary policy point of view, Mr Svensson reminded the meeting that how expansionary or contractionary monetary policy is is determined by four factors: the market's expectations regarding future repo rates, the spreads between market rates and the repo rate (which determine the market rate when the repo rate is close to zero), inflation expectations (which determine the real repo rate and the real market rate) and the real exchange rate (which together with the real market rate determines how expansionary or contractionary monetary policy is)..."
While a small negative interest rate solution may co-exist without a random bebasement of currency notes (pl see Professor Gregory N. Mankiw's "It may be time for the Fed to go negative", The New York Times,18-Apr-09.),a significant (like -2%) "negative interest rate solution" cannot exist as a temporary one-off measure. Since the idea is to stimulate consumption, I presume that whenever the negative interest rate solution (say with a negative Fed Funds target rate accompanied by debasement of some currency notes...) is implemented, no part of the yield curve will be positive. As otherwise, there could be a postponement of demand rather than its preponement.It might be possible to make risk-free profit in a scenario where the entire yield curve is below zero, by effectively locking into a negative borrowing cost for a future date (if a negative interest rate regime does not recur). And since risk-free profit is impossible in equilibrim, I say that the recurrence of a negative-interest rate regime has a non-zero probability i.e. a negative interest rate regime may recurr.
You may like to read my earlier weblog "Negative nominal interest rates in the US?".
Posted by amgodbole at 08:29 AM
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August 01, 2009
Googling Sentiments...
Larry Summers, Economic Adviser to the US government, recently mentioned that the more normal levels of the search "economic depression" is an indication that the economic free-fall has ended.
Professor Gregory N. Mankiw, in his weblog entry entitled "Google searches as an economic indicator" authored on the same day (17-Jul-09) on which Summers made his remarks,gives the relevant graph. That graph follows:
Interestingly, the graph looks very different today (1-Aug-09). In fact the "economic depression" Google Trends graph shows that the search volumes have reached a new all-time high.
So, has a new free fall begun.
Note: The "news reference volume" has not taken the same direction as the "search volume index".
Posted by amgodbole at 07:13 PM
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