Reporting on Japan’s Move to Negative Interest Rates — Confessions of a Supply-Side Liberal

Anjani Trivedi, Eleanor Warnock and Greg Ip’s Wall Street Journal article “Central Banks Go to New Lengths to Boost Economies: Bank of Japan’s move to negative rates is the latest attempt to spur growth,” is a good example of the still inadequate reporting about negative interest rates. The revision noted that it had input from Tommy Stubbington, whom I praised in “The Wall Street Journal Gets It Right On Negative Interest Rate Policy, Thanks to Tommy Stubbington,” and was noticeably better, though in a spotty way. Let me give my reactions to some important passages.

Basic Reporting

The reporting at the beginning of the article is well done. I particularly appreciated the discussion of international linkages:

Japan’s move washed through currency markets, driving the yen down by as much as 2.2% against the dollar, and showed how easing by one central bank puts pressure for similar moves by others.

By strengthening the dollar, the continued loosening of monetary policy in Japan and Europe could complicate the Fed’s aim of gradually notching up interest rates this year. Measured against a basket of 16 currencies, the dollar this week hit its highest level in more than 13 years.

and how massive paper currency storage has not yet appeared in Europe:

… the move in Europe into negative rates has so far created no evident disruptions for money-market funds or a flight to cash by depositors, giving a green light for banks to consider going further.

“Adverse effects on money market functioning have been limited,” Stanley Fischer, the Fed’s vice chairman, said in a speech this month. “Cash holdings have not risen significantly in these countries, in part because of nonnegligible costs of insuring, storing, and transporting physical cash.”

I was surprised by how low Sweden has gone:

No one knows how low negative rates can get before those costs become an inducement to hold cash, but probably beyond the minus .75% rate now charged in Denmark and the minus 1.1% in Sweden.

And the article pointed out an important fact, which I discussed on Wednesday in relation to two-tiered negative deposit rates in the euro zone:

Few banks have so far passed on those negative rates to small retail depositors.

Looking forward, this is an interesting prediction:

In a note to clients Friday, Citigroup economists predicted the ECB and the Swedish and Danish central banks would cut their policy rates even further into negative territory in coming months, and their counterparts in Canada, Australia, Norway and even China may do so “should macroeconomic conditions turn out even weaker than currently expected.”

Analysis

As the article moved from reporting to more analysis, the quality declined. For example, the authors needed a counterpoint to Raghuram Rajan’s declaration

… stimulus doesn’t cut it anymore and certainly monetary policy has largely run its course.

Guess what–monetary policy hasn’t run its course at all. In my most recent visits to central banks, my advice has been to choose the policy rate as if there were no zero lower bound–because there isn’t a zero lower bound for any central bank that knows what it is doing. And increasingly, central banks do know how to defeat the zero lower bound. My bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” gets a steady stream of pageviews, many of which I am confident are from central bank staff around the world. And I have been to a fair number of central banks in person. For journalists to understand everything central bankers are thinking, they need to read some of what I have written. Otherwise, they will get things wrong.

Even more misleading is this quotation with no counterpoint:

Central bankers “are running out of things to do,” said Sean Yokota, head of Asia strategy at Nordic bank SEB.

This is first, false, since a lot remains to be done in the direction of negative interest rates. Secondly, it seems to suggest that negative interest rates are a last resort. No! Negative interest rates were always likely to be much more effective than quantitative easing. Quantitative easing was tried first primarily because the intellectual preparation for quantitative easing was further along than the intellectual preparation for negative interest rates when central banks felt the need for another tool.

The Power of Negative Rates

The reporting was fully appropriate in giving this quotation,

Despite the day’s surge, some investors remained skeptical about the lasting impact of the central banks’ efforts. “People are starting to feel more and more that central bank action is having less and less fire for effect,” said Ian Winer, head of equities at Wedbush Securities.

but I want to take issue with Ian Winer himself. I want to insist that the power of negative interest rates be judged per basis point. Given the mild negative interest rates so far, the effects have been substantial per basis point reduction. The size of the effects is especially impressive when one realizes that only the weak version of negative interest rates has been used so far. As I wrote in “The Swiss National Bank Means Business with Its Negative Rates,”

There is a world of difference between a central bank that cuts some of its interest rates, but keeps its paper currency interest rate at zero and a central bank that cuts all of its interest rates, including the paper currency interest rate. If a central bank cuts all of its interest rates, including that paper rate, negative interest rates are a much fiercer animal.

The ability to reduce the paper currency interest rate using the tools you can see discussed here makes it so that interest rates can be reduced by as many basis points as needed.

How Much More Slack Is There There in Japan’s Economy?

It is very difficult to know exactly how much slack is left in Japan’s economy. I lean toward the view that there is still substantial slack left. Try this thought experiment on for size. Suppose that, instead of trying with all its might to talk inflation up, the Bank of Japan were doing everything it could to keep inflation expectations down while using negative interest rates to stimulate the economy as much as it is being stimulated under current policy. Would inflation now be rising? If your answer is no, then you think the Japanese economy has slack.

Even if, contrary to my own guess, the Japanese economy is already at its natural level of output or a little beyond, given the objective of raising inflation, it doesn’t make sense to think that monetary policy has been too stimulative until there is more inflation than desired, or a path that looks as if it will lead to more inflation than desired. One of the reforms mentioned in the article is really about trying to raise inflation:

Labor reforms that give benefits to contract workers so wages can rise more broadly

This seems like a reform aimed at getting more inflation. But given that as much monetary stimulus as desired can be provided by negative interest rates, there is really no reason to desire more inflation. Japan can stimulate its economy as much as desired without any extra inflation. It certainly should be willing to risk more inflation than the current level of inflation in order to learn more about what its natural level of output is, but if negative interest rate policy is fully embraced in the way I have recommended, there is no longer a strong reason to desire more inflation. Other than the neutering of monetary policy by the zero lower bound, low inflation has not caused Japan serious problems (perhaps in part because its annual bonus system reduces downward nominal rigidity of wages in Japan). And the zero lower bound is a dragon that can easily be slain now that the soft underbelly of the zero lower bound has become fully apparent.