## Wednesday, September 21, 2016

### Negative rates and inflation

Have negative interest rates boosted inflation? Here is a nice graph (source macro-man blog, HT FT alphaville)

 Source: Macro-man blog
Not really. Explanations? Choose the chicken or the egg:

1) But for negative rates, inflation would have been even lower

2) We're living in a Fisher effect world. Lower rates lower inflation. (Which is arguably a good, if unintended, thing)

1. Worth noting that Sweden, Denmark and Switzerland have set negative interest rates not because they are trying to boost inflation but to maintain their pegs against the Euro.
(Sweden and Switzerland as much heavily managed as strictly pegged, but Danish peg is strict: https://plot.ly/~robertdkirkby/1509/danish-krone-is-pegged-to-euro/ )
[Fixed exchange rate, plus open capital flows, means they don't get to set their own monetary policy interest rates; as per Impossibility Trilemma of international trade.]

As you observe with chicken & egg interpretation it is not clear what you learn from this exercise. Nor is it clear what one might hope to learn from this exercise? While it looks nice it essentially constitutes non-evidence of anything.

[As part of an assignment I have students read a newspaper article arguing that since inflation and interest rates have a high positive correlation money is short-run neutral and interest rates then just are determined by inflation via fisher eqn. I then have them calculate the same correlation in simulated data from a basic new keynesian model, in which money is explicitly non-neutral in short run. The lesson is supposed to be that in a dynamic economy with lags, expectations, and endogeneity drawing any conclusions about causation from raw correlations is an exercise bound to end in tears.
(Q2 in https://www.dropbox.com/s/99rva2ktih6lkh8/ModelsDataEconomics_ProblemSet.pdf?dl=0)]

PS. Rereading this post it sounds a bit rude, this is not the intention. I do like the graph at a visual level and plan to reuse it myself.

2. "Not really. Explanations? Choose the chicken or the egg."

This is not a well constructed chart.

Denmark went slightly negative back in 2011 but then went positive. January 2015 was when it really took a deep dive into negative rate land. The chart implies that rates have been negative over this entire period. As for the Swiss, the chart says rates went negative back in 2011, but this simply isn't the case. The Swiss only dropped into negative territory in 2015.

3. I don't think simply plotting the data says much about the effect of negative rates (or any other policy for that matter). We need the counterfactual!

4. wow, there are negative interest rates boosted inflation in scandinavia, euro zone and Japan

5. Can Japan keep interest rates where they are and use the Bank of Japan to pay off the national debt?

Side question: Japan has issued lot of bonds. Now that the BoJ is buying back bonds, some banks say they are having liquidity problems and cannot sell any more bonds. We hear variations of this in US and also a "safe asset shortage" problem.

How is this? Banks need governments to issue bonds?

6. Interest rate adjustments are all hogwash. There is no reason to assume, given inadequate demand, that the problem is inadequate borrowing, lending and investment rather than inadequate spending on education, beef-burgers, whiskey, infrastructure or chewing gum.

7. Why don't these interest rates, what you call "policy", simply reflective of slow NGDP growth?

High interest rates are associated with loose monetary policy; and low rates are associated with tight monetary policies. Negative rates simply reflect ongoing tight monetary policy at the BOJ.

Interest rates are just the price of debt. *A truly stimulative policy by the central bank would slaughter the present value of debt markets.* Bonds must become "certificates of confiscation". There is your standard of policy stimulative "success" - are yields rising or falling?

Negative rates boost the present value of debt markets, and so are de factor part of tight NGDP-unfriendly monetary policy. Zero surprise, not even worth the pixles.

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