Yield Bugs — Brian Romanchuk

Joe Weisenthal has been causing a stir on Twitter discussing "yield bugs": people who have an ideological belief that bond yields out to be positive. This Bloomberg opinion piece discusses this, as well as some other comments on negative yields coming to the United States. I have not followed that debate too closely, as I initially assumed that there was not a whole lot of people who believed that bond yields ought to be positive. This is because bond yields are essentially determined by central bank expectations, and there is not a lot stopping central banks from pushing short rates to negative values....

Bond Economics
Yield Bugs
Brian Romanchuk

Origin of the 2 Percent Inflation Target — J. Barkley Rosser

So it was 1990 that the New Zealand central bank became the first in the world to impose an inflation target of 0-0.002....

Econospeak
Origin of the 2 Percent Inflation Target
J. Barkley Rosser | Professor of Economics and Business Administration James Madison University

Brian Romanchuk — Bear Market Meditations

Many of Brian's posts are somewhat specialized and of interest chiefly to those involved in bond markets and fixed income assets, or who seek a more detained understanding from a Post Keynesian perspective that is also in paradigm with MMT. 

This installment will be of interest to everyone with an interest in MMT and Post Keynesian economics and its approach to finance, as well as anyone interest in the general features of the current market. 

Easy read even with a pretty minimal understanding of the subject, as most people following MMT may be presumed to have acquired. If you haven't been following Brian, this is a good place to begin.

Bond Economics
Bear Market Meditations
Brian Romanchuk

Brian Romanchuk — No More Neutral Rate?

A bit wonkish (but no math), but interesting if you are into interest rates and how they affect the economy.

Bond Economics
No More Neutral Rate?
Brian Romanchuk

Brian Romanchuk — Japan And The Costs Of Bond Yield Control

The dangers of distorting free market interest rates is one of the bits of market folklore that keeps getting passed around. There is actually not a whole lot of data to defend this view; it is best viewed as faith-based reasoning. This topic is particularly interesting in the case of Japan. I am somewhat agnostic on this issue; I do not see particular risks from manipulating the yield curve in the current environment, yet I can see some plausible dangers.

This article was triggered by the article "Bank of Japan once again shows who calls the shots," by Bill Mitchell, one of the leading Modern Monetary Theory (MMT) economists. In addition, I had a discussion about this topic with someone doing some research awhile ago. Rather than re-hash Professor Mitchell's points from the MMT perspective, I will put on my "generic market analyst" hat and give a description of the issue from a more theory-agnostic perspective....

Bond Economics
Japan And The Costs Of Bond Yield Control
Brian Romanchuk

Bill Mitchell — Bank of Japan once again shows who calls the shots

On August 1, 2018, the 10-year Japanese government bond yield, shot through the roof (albeit a very low one). Yields shifted from 0.05 per cent on July 31 to 0.129 on August 1, which was the largest one-day rise since July 29, 2016 (when the yield rose 0.101 per cent). The Financial Times article (August 1, 2018) – Japanese bond market jolted as traders test BoJ resolve – wrote that “traders wasted no time in testing the Bank of Japan’s resolve to loosen its target range for the debt benchmark”. So what was that all about? And what key point does it demonstrate that seems to be lost on mainstream economists who continually claim that government debt is, or can become a problem once bond markets demand higher yields? The Japanese bond market has shown once again that private bond traders cannot set yields on government bonds if the central bank intervenes. Next time you hear some mainstream economist claiming a currency issuing government is running deficits at the will of the investors (read bond markets) politely tell them they are clueless. Japan once again provides the real world Modern Monetary Theory (MMT) laboratory – every day it substantiates the underlying insights contained within MMT and refutes the core mainstream propositions. The bond market over the last month or so demonstrates that the Japanese government is increasingly net spending by using credits created by the Bank of Japan, whatever else the accounting structures might lead one to believe. With inflation low and stable, these dynamics surely put paid to the various myths that a currency-issuing government can run out of money and that central bank credits to facilitate government spending lead to hyperinflation....

Bill Mitchell – billy blog
Bank of Japan once again shows who calls the shots
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Brian Romanchuk — The Yield Curve Provides Limited Economic Information

The relentless flattening of the Treasury yield curve has been a topic of ongoing debate -- is this a signal that a recession is near? The key to interpreting the flattening is that bond market participants are not paid to to anticipate economic outcomes (outside the corner case of the inflation-linked market), rather to anticipate the path of short-term rates (and the term premium). The flattening yield curve tells us that market participants (on average) believe that we are near the end of the rate hike cycle, but that does not necessarily mean that a recession is imminent....

Bond Economics
The Yield Curve Provides Limited Economic Information
Brian Romanchuk

Brian Romanchuk — Initial Comments On Zero Rate Policy And Inflation Stability

This article represents my initial comments on the question of the stability implications of locking interest rates at zero. Martin Watts, an Australian academic, had an interesting presentation at the first Modern Monetary Theory (MMT) conference (link to videos of presentations). Although MMT fits within a broad-tent definition of "post-Keynesian" economics, there are still sharp debates with other post-Keynesians. One topic of debate is the effect of permanently locking the policy interest rate at zero, which is a policy advocated by many MMT economists. In my view, this is a debate that is best approached by using stock-flow consistent (SFC) models.

Bond Economics
Initial Comments On Zero Rate Policy And Inflation Stability
Brian Romanchuk

James Hamilton — How the Federal Reserve controls interest rates

Good short summary of how central banks manage interest rates within a corridor with a floor rate and a ceiling rate. Hamilton compares and contrasts ECB and Fed operations.

Econobrowser
How the Federal Reserve controls interest rates

James Hamilton | Professor of Economics, UCSD

Bill Mitchell — More fun in Japanese bond markets

The Japanese bond market has been very interesting in the last week proving yet again that private bond markets cannot set yields on government bonds if the government does want then too. Next time you hear some mainstream economist claiming a currency issuing government is running deficits at the will of the investors (read bond markets) politely tell them they are clueless. Japanese once again provides the real world Modern Monetary Theory (MMT) laboratory – every day it substantiates the underlying insights contained within MMT and refutes the core mainstream propositions. The financial media referred to the Bank of Japan as putting a whipsaw to the bond markets, which in context means that the BoJ is forcing the ‘markets’ into confusion (Source). The bond markets have misinterpreted recent Bank of Japan conduct in the JGB markets (less purchases than expected, and even missing a scheduled buy up) as a sign that the Bank was weakening on its QQE commitment from last September that it would hold the 10-year JGB yield to zero and thereby allow the longer investment rates to fall. Why they doubted that commitment is another matter but within a few days over the last week the Bank demonstrated that: (a) it remains committed to that target; and (b) it has all the financial clout it needs to enforce it; and (c) the bond market investors do not call the shots....

Bill Mitchell – billy blog
More fun in Japanese bond markets
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

Claudio Borio, Piti Disyatat, and Anna Zabai — Helicopter money: The illusion of a free lunch – UPDATED

UPDATE: Scott Fullwiler (STF) clears this up in the comments below. 

Seven years on from the great financial crisis and despite central banks being seen by many as ‘the only game in town’, there has been a renewed push for monetary policy to experiment even further. One of the latest proposals is the revival of Milton Friedman’s ‘helicopter money’. But have all the implications of what many see as central banks’ ‘nuclear option’ been fully appreciated? This column argues that this is not the case. Realising the benefits that its proponents claim exist would require giving up on interest rate policy forever.…

Given the intrinsic features of how interest rates are determined in the market for bank reserves (bank deposits at the central bank), the central bank faces a catch-22. Either helicopter money results in interest rates permanently at zero – an unpalatable outcome to most, including those that advocate monetary financing1 – or else it is equivalent to either debt or to tax-financed government deficits, in which case it would not yield the desired additional expansionary effects.

This seems wrong to me. The central bank could continue to set rates by paying IOR. [Scott Fullwiler addresses this in the comments.]

This seemingly innocuous technical detail has major implications. The central bank can of course implement a permanent injection of non-interest bearing reserves and accept a zero interest rate forever (scheme 1). This produces the envisaged budgetary savings but at the cost of giving up completely on monetary policy. If the central bank wishes to avoid that outcome, it has only two options.3 It can pay interest on reserves at the policy rate (scheme 2), but then this is equivalent to debt-financingfrom the perspective of the consolidated public sector balance sheet – there are no interest savings.4 Or else the central bank can impose a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion (so that excess reserves remain unchanged – scheme 1), but then this is equivalent to tax-financing – someone in the private sector must bear the cost.5 Either way, the additional boost to demand relative to temporary monetary financing will not materialise.

Seems to confuse monetary and fiscal. What actually acts like a tax is not paying interest on debt, which would increase the aggregate net financial assets of non-government, with the helicopter infection doing so instead.

The difference is that the liability in this case would slow up on the books of the central bank rather than the Treasury.

What would disappear is the illusion of the intertemporal budget constraint, replaced by the illusion of "free money." Money is never "free" in that it is a financial instrument and financial instruments are always recorded as a liability on the issuer's balance sheet.


VoxEU
Helicopter money: The illusion of a free lunch
Claudio Borio, Head of the Monetary and Economic Department, Bank for International Settlements; Piti Disyatat, Director of Research, Bank of Thailand.and Anna Zabai, Economist, Bank for International Settlements

Jason Smith — Matthew Yglesias is still withholding the economic theory of everything

Smackdown.

Information Transfer Economics
Matthew Yglesias is still withholding the economic theory of everything
Jason Smith

Brian Romanchuk — Policymakers And The Confidence Fairy [Paul Krugman, Larry Summers, and Brad DeLong]

The trio of Paul Krugman, Larry Summers, and Brad DeLong once again are arguing about policy. And once again, they are showing the limitations of the blinkers that mainstream economics imposes upon its true believers. Larry Summers in this article defends the Fed Reserve rate hike on the grounds of the need of monetary policymakers to preserve "confidence" in the currency, which generated this response by Brad DeLong. Throughout the debate, the factoid that rate hikes improve investor confidence is assumed, without any reflection whether this is actually the case.…

Bond Economics
Policymakers And The Confidence Fairy
Brian Romanchuk

Jérémie Cohen-Setton — Blogs review: Understanding the Neo-Fisherite rebellion

Neo-Fisherism is on the blogs again. The idea that low interest rates are deflationary – that we’ve had the sign on monetary policy wrong! – started as a fringe theory on the corners of the blogosphere 3 years ago. Michael Woodford has now confirmed that modern theory, indeed, implies the Neo-Fisherian view when people’s expectations are infinitely rational. For Woodford, this is however a paradox of perfect foresight analysis, rather than something actually relevant for monetary policy.

Monetarists will be monetarists. But if you want a quick summary of what's going on over there, here it is.

Bruegel
Blogs review: Understanding the Neo-Fisherite rebellion
Jérémie Cohen-Setton

Liberty Street Economics — Why Are Interest Rates So Low?

Everything you wanted to know about the natural rate of interest as the core of monetary policy and how it is estimated, being unobservable. That is, the natural rate of interest  a theoretical term in general equilibrium neoclassical theory based on Knut Wicksell. The post discusses different ways to estimate it used by economists in forecasting and central banks in policy formulation.

High accessibility/low wonkishness.

FRBNY — Liberty Street Economics
Why Are Interest Rates So Low?

Marco Del Negro, Marc Giannoni, Matthew Cocci, Sara Shahanaghi, and Micah Smith

Brian Romanchuk — Understanding Central Bank Control Of Interest Rates

One topic that periodically comes up is the issue of whether bond yields are "controlled" by the central bank, or whether they are set by "market forces". The typical context of the discussion is whether the bond markets can force governments to follow certain policies. I am in the camp that the central bank does "control" bond yields, but there are some subtleties in understanding how that control is defined.

Bond Economics
Understanding Central Bank Control Of Interest RatesBrian Romanchuk

Federal Reserve to begin test running new Term Deposit Facility (TDF)

Just this morning, the Federal Reserve Board of Governors announced that they will begin test running the new Term Deposit Facility, which was created in a final rule back in June of 2010 (link). This rule amended the Fed's Regulation D to allow for the auction of these new term deposits. I'm not entirely sure if this was the Fed's own initiative, or if it was a new authority granted the Financial Services Regulatory Relief Act of 2006, or some GFC related statute.

So now, in addition to paying interest on excess reserves through the new Excess Balance Accounts, the Fed  has another tool at its disposal to maintain a non-zero interest rate, without selling Treasury securities in open market operations. In other words, its now possible for the Fed to do QE-Infinity, buy up all the Treasury Securities on the market, and still maintain an overnight interest rate above zero. This new term deposit facility is basically just the Fed selling its own short term Certificates of Deposit (CDs), in order to provide an interest bearing alternatives to plain reserve balances. To be clear, these new term deposits do not satisfy an institution's required reserve balance or clearing balance and do not constitute excess balances. They are not available to clear payments and cant be used to reduce daylight or overnight overdrafts. 

According to the Fed, 

Term deposits may be awarded through a competitive single-price auction format with a non-competitive bidding option, a fixed-rate format at the interest rate specified in advance, or a floating-rate format. The interest rate paid on term deposits awarded through a floating-rate format will be the operation effective interest rate, which is determined by the average of the daily effective rates over the term of the instrument. 

However, just as with the interest-bearing Excess Balance accounts, Fannie, Freddie, and the Federal Home Loan Banks are not  eligible for this program. This means that they will continue to trade in the Federal Funds Market, which is why the effective Federal Funds Rate remains below the 25 basis points payed on excess reserve balances.As an aside, in the text of the final rule establishing the Excess Balance accounts, the Fed refers to un-remunerated reserve requirements as a "tax", just as Warren Mosler has.

I see this new facility as a modernization of monetary policy, which should make all the operations simpler to execute, and more importantly, easier for the general public to understand. Most people understand how CDs work, and these TDF are similar. For that reason, hopefully this test run will be successful, and will help us MMTers make our points, especially since Professor Scott Fullwiler has written extensively on these new advancements.

More information is available here. 

So can we please stop selling Treasury debt now? Its 2014 for Eccles' sake!

Slide Deck: MMT Knows- the Fed Sets Rates

I've been working on a powerpoint presentation laying out some MMT basics. Ideally, it could be presented to members of Congress and staffers to help them better understand our modern system of public finance. Link here

Bill Mitchell – The last eruption of Mount Fuji was 305 years ago

The Report obviously doesn’t comprehend what it means for a central bank to be the monopoly supplier of bank reserves in this case denominated in Yen.

There was a reference to this capacity in a 2004 paper written by Ben Bernanke, Vincent Reinhart, and Brian Sack – "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment."

The authors examine the future of monetary policy when short-term interest rates, the principle tool of monetary policy get close to zero (as they are now).

They discuss various strategies that a central bank can take to alter the composition of its balance sheet “in order to affect the relative supplies of securities held by the public.”

That is, the amount of bonds held by the non-government sector.

The authors noted that:

Perhaps the most extreme example of a policy keyed to the composition of the central bank’s balance sheet is the announcement of a ceiling on some longer-term yield, below the rate initially prevailing in the market. Such a policy would entail an essentially unlimited commitment to purchase the targeted security at the announced price.

And would completely control longer maturity yields – which means end of scary future a la the neo-liberal economists who seek public attention but cannot tell the same public the truth.

The above authors (Bernanke et al) also state (in a footnote on page 25) that:

In carrying out such a policy, the Fed would need to coordinate with the Treasury, to ensure that Treasury debt issuance policies did not offset the Fed’s actions.

Which means that the two arms of government operate as a consolidated policy sector and target the same aim – maximisation of public purpose.....

The authors also suggest that it is possible that:

… even if large purchases of, say, a long-dated Treasury security were able to affect the yield on that security, the possibility exists that the yield on that security might become “disconnected” from the rest of the term structure and from private rates, thus reducing the economic impact of the policy.

That is possible. The corporate rates which reflect risk as well as inflationary expectations might deviate.

The overall point is that when there are transaction costs and “financial markets are incomplete in important ways”, the central bank can influence “term, risk, and liquidity premiums — and thus overall yields.”

The authors note that historically the strategy has been successful in a number of countries and give examples. Among the examples, they consider the “historical episode” that became known as “Operation Twist”.

I considered the issue of how the central bank can control the bond yield curve at all maturities in this blog – Operation twist – then and now.

So there is never a situation where the bond markets can destroy a nation which has currency sovereignty. Never means NEVER.

Bill Mitchell – billy blog
The last eruption of Mount Fuji was 305 years ago
Bill Mitchell

Bill Gross — There Will Be Haircuts

Bill Gross reflects on money and admits that the central bank sets the interest rate and controls the yield curve as it wishes, and he doesn't like it one bit. He would much rather be a bond vigilante.

...central banks are doing the same thing with near zero-bound yields and effective caps on higher rates via quantitative easing.

PIMCO Investment Outlook
There Will Be Haircuts
William H. Gross