Some Selections Related to Negative Interest Rate Policy from the General Discussions at the 2016 Jackson Hole Symposium on "Designing Resilient Monetary Policy Frameworks for the Future"
I was honored to be invited to the 2016 Jackson Hole Monetary Policy Symposium. At the time, I tweeted
At Jackson Hole I am like a kid in a candy shop. Lunch with Ben Bernanke and the very impressive Haruhiko Kuroda. Hike with John C. Williams.
I participated actively in the general discussion after each paper. The most remarkable paper was Marvin Goodfriend's paper "The Case for Unencumbering Interest Rate Policy at the Zero Bound," which I highly recommend. Let me give you some excerpts from those discussions.
On "The Case for Unencumbering Interest Rate Policy at the Zero Bound" by Marvin Goodfriend
Miles Kimball: I think this is a very interesting discussion. I think there’s an important message here which is that already any central bank that has a little political running room should set interest rates as if there is no lower bound because it is actually quite easy to eliminate the zero lower bound. On the particular approach to eliminate the zero lower bound, Ruchir Agarwal and I have an IMF working paper, “Breaking Through the Zero Lower Bound,” that argues that a crawling peg can be implemented and defended very, very smoothly, contrary to what Marvin Goodfriend said. I also want to say that it’s a big deal for anyone to do the deep negative rates because any central bank using deep negative rates even once would avoid the downward pressure on long-term rates from markets thinking falsely that central banks might run out of ammunition. And so it would be a great, good turn for the world if any central bank implements deep negative rates just to demonstrate that there is plenty of monetary policy ammunition no matter what we face. There’s also another big benefit of being able to use deep negative rates that you can have quicker closing of output gaps. The last thing I want to say is in terms of the politics, I think the issues of bank profits can easily be dealt with by a lot of mechanisms and it’s also very easy for central banks to subsidize the provision of zero rates to small household accounts, by just using the interest on reserve formulas. So that’s a proposal I’ve made which I think can very much improve the politics of negative interest rates.
Marvin Goodfriend: Let me reiterate that a main point of my paper is that central banks don’t have a choice about long-term real interest rates. Long-term rates are governed largely by real forces outside the purview of monetary policy. Rather, central bank interest rate policy must accommodate long-term rates in order to sustain a low targeted rate of inflation. Monetary policy is about managing short-term interest rates. Short-term nominal interest rates have had to fall a few percentage points below long-term nominal bond rates in the United States to stimulate the recovery from each of the eight recessions we’ve had since 1960. If inflation and inflation expectations are stabilized at a 2 percent target and real bond rates remain non-negative as seems reasonable, then nominal bond rates should remain somewhat positive. In that case, deeply-negative short-term nominal interest rates may not be needed except perhaps temporarily to stimulate the recovery from recession. In large part, short-term interest rate policy stimulus works by coordinating an increase in spending, first to help offset contractionary dynamics and then to help initiate a cyclical expansion. If employed promptly and decisively against recession, interest rate policy would not likely sustain deeply negative nominal short-term interest rates for very long. I agree it’s not popular for central banks to say they might make short-term interest rates negative, even temporarily. That’s why I wrote the paper from the perspective of monetary history. It wasn’t popular when central banks left the gold standard. It wasn’t popular when fixed exchange rates were abandoned. Even though there were good reasons to do so. It took a long time for the public to get comfortable with a flexible money price of gold and later with flexible foreign exchange rates. Taking a longer-run perspective, it’s taken hundreds of years for the world to accept flexibility in relative prices as necessary to allocate goods and services to their most valued uses in society. Thomas Aquinas, notably among a host of other thinkers, thought of prices largely in terms of fairness rather than allocative efficiency. The real intertemporal terms of trade is one of the most controversial relative prices in this regard. This is so in part because of the widespread misapprehension that central banks are free to choose interest rate policy as they see fit, which tends to perpetuate the erroneous view in some quarters that interest rate policy is a matter of balancing fairness and allocative efficiency. Let me come to the comment about Argentina. It’s been a great laboratory and I’d like to hear more about that. On Miles Kimball’s point, we both recognize the feasibility and desirability of negative interest rate policy, and have said so in our own ways in the past. The point I’m emphasizing in my paper today is that interest rate policy can and should be unencumbered expeditiously in a future crisis so that negative nominal interest rates can be made freely available and fully effective as realistic policy option. Kristin Forbes raised an important concern about insurance companies and pension funds. In the past, insurance and pension services have been bundled with promises of significant positive returns. They’ve been bundled saying, “We will promise you a high long-term yield and we will also provide you insurance.” The bundled promised return will not be viable in a low-interest world. However, that is not a problem for monetary policy; it’s a problem for business practice.
[Everyone had the chance to edit their remarks. Unedited, what Marvin said in response to my comment was
On Miles Kimball’s point, you know Miles and I are allies on this, and I’d like to talk to him about the crawling peg and the feasibility. Maybe I’m wrong, I don’t know. But basically we’re in the same camp as this is something that should happen and can happen.]
On "Evaluating Alternative Monetary Frameworks," by Ulrich Bindseil
From Jean-Pierre Danthine's Discussion (see also his post and paper "The Interest Rate Unbound"):
I start from the observation that commercial banks have universally been very reluctant to pass on negative rates to their retail clients. This reluctance can be understood as the result of two facts. First, retail clients have been forever the prime source of low-cost funding for banks and thus key to the profitability of their maturity transformation operations. Second and importantly, negative interest rates are very unpopular. They are counterintuitive for the man in the street and generally seen as a measure of financial repression. In this context, bankers are understandably fearful that imposing negative rates at the retail levels will lead to the permanent loss of their prized retail clientele. And it is a fact that retail depositors have not been affected by this monetary policy measure (except in the form of higher banking fees) in any of the five economic areas with negative policy rates. With this configuration, paper currency hoarding by the general population is not a threat and preventing hoarding at the wholesale level should be enough to permit a significant lowering of the effective lower bound (ELB). To achieve that outcome, a modest design add-on should do: the ability to impose a fee on paper currency withdrawal at the wholesale level. The fee structure should be independent of handling costs so that it can be tailored to the depth of negative rates and the anticipated duration of such a regime. It would be exclusively preventive with the goal of making paper currency hoarding unprofitable (thus the fee would never be levied). It is true that, the lower the rate, the larger the pressure on the profitability of the banking system given the fact that market rates are affected by the policy measure. To a large extent this pressure can be alleviated by an OF innovation mentioned by Bindseil, the excess reserves tiering systems, by which the bulk of excess reserves is exempted from the application of negative rates. The Swiss experience is conclusive on this score: bank profitability has been maintained in 2015 (it has actually improved) despite the introduction of negative rates in mid-January. This is not Commentary 285 to say that the current environment is not challenging for banks (or for that matter other financial institutions such as pension funds and wealth managers) but this has more to do with low rates on all assets than with negative rates on cash per se. This “minimal” way of lowering the ELB has one big advantage: with the retail depositors not affected by the negative rates, public acceptance of the policy stands a much better chance (even if it is not straightforward). It also has its drawback, in particular, it will not be effective if the objective of the policy is to provide a “classical” monetary stimulus in a bank dominated financial system. In Switzerland, bank lending rates have been only marginally affected by the negative rate policy and mortgage rates have actually increased after the introduction of negative rates. For a small open economy in search of an appropriate interest rate differential to moderate the strength of its currency, however, the exclusive transmission of negative rates to market instruments is sufficient and such a way of lowering the ELB would be of great help.
Miles Kimball: I just wanted to highlight Jean-Pierre Danthine’s remark about the ability to attain medium low rates, say minus 200 basis points even without taking paper currency off par. In particular, by encouraging zero rates for households (in ways I would add that don’t hurt the bank profits too much) you can subsidize that through the interest on reserve formula, and then you can make the wholesale storage of paper currency difficult. There was a very, very interesting Brookings conference on negative rates on June 6 that has the videos all online where these kinds of issues were discussed very nicely.
On Chris Sims's Lunch Talk: "Fiscal Policy, Monetary Policy and Central Bank Independence."
[There is no transcript of this discussion, but I report on my question and Chris Sims's answer in my post "Negative Rates and the Fiscal Theory of the Price Level."}
On "Central Bank Balance Sheets and Financial Stability" by Robin Greenwood, Samuel Hanson and Jeremy Stein
Miles Kimball: I want to say first that this is a brilliant paper, discussion and presentation. I think this is an excellent idea. I wanted to say I think this overnight reverse repurchase agreement (RRP) program is important for a very large number of reasons. I want to talk about it in relation to having in your quiver things that will help you with negative interest rate policy. First, it’s something that helps reinforce the electronic unit of account. The second thing that’s good about the RRP is that you can probably legally have negative interest on reserves, but you don’t even have to do that because you can cap the reserves at slightly above required reserves and then just use the RRP program for the same function that you would have used interest on reserves and have that go negative. Then the final thing relates to this problem of people moving to the RRP; I think the right answer is you just drop the interest rate on RRP very, very fast, along with the fed funds rate when you do get into that crisis.
[Jeremy Stein made no direct response to my comment. My post the following Monday, "How the Fed Could Use Capped Reserves and a Negative Reverse Repo Rate Instead of Negative Interest on Reserves" elaborated on my point.]
On "Funding Quantitative Easing to Target Inflation," by Ricardo Reis
Miles Kimball: This is a question for both of you [Ricardo Reis and discussant Laura Veldkamp] because you’ve questioned some of the channels through which QE might affect the economy. Yesterday, Chair Yellen showed a chart where the combination of QE and forward guidance could do almost as well as lowering interest rates by 400 basis points. Given your read on QE being a little different, but adding in the forward guidance, do you think that assessment of how well QE and forward guidance alone without deeper interest rate cuts could stabilize the economy is realistic?
Ricardo Reis: On Miles Kimball’s question, the point that I am making is that in spite of all of the richness in asset purchases and all the diversity of assets in the balance sheet, in spite of this being perhaps a new world where the market for reserves is saturated, I am making a strong claim that we are back to normal in the sense that it is interest rate policy that controls inflation. Whether interest rates are negative or positive, whether they follow rules or using discretion, whether that is with more forward guidance or less forward guidance, we have a long literature and history of thinking about these issues. I am arguing that we should discuss interest rate policy as the primary way to control inflation.
Laura Veldkamp: I was going to respond to what Miles Kimball said. Yes, I believe in forward guidance. I think that that is an effective tool for controlling expectations, but I don’t think that that eliminates the fear of tail risk. I’m not sure what in those scatterplots would lead us to believe a financial crisis is not possible.
On Haruhiko Kuroda's handout in the Overview Panel: "Re-Anchoring Inflation Expectations via ‘Quantitative and Qualitative Monetary Easing with a Negative Interest Rate’"
Miles Kimball: So, I think there’s an explanation for Chart 4 that Governor Kuroda showed about the JGB yield curve coming down, that Massimo Rostagno talked about at the Brookings conference in June. And that’s if people think interest rates can only go up from zero, then out in the future, you’re going to have the yield curve go up more. And so I think it’s hugely valuable when you bring down market expectations about the effective lower bound. And Massimo argued that that was very complementary with a quantitative easing policy.
Haruhiko Kuroda: .... you can look at the last chart, JBG yield curve, the highest one is the yield curve just before we introduced QQE. The middle curve 542 Chair: Kristin J. Forbes is the yield curve just before we introduced the negative interest rate. So, almost three years of substantial QQE, yes, reduced the nominal interest rate, but to this extent. And actually in this period, more important was real interest rate decline caused by increased inflation expectations. That was the sort of first year and a half or something like that. And then, the lowest yield curve shows the yield curve at this moment. This shows that negative interest rate of minus 0.1 percent on a marginal amount of deposits caused a substantial decline of the yield curve. The short end declined by 20 basis points. We reduced interest rates by 20 basis points at the short end. But the long end, it showed a quite substantial decline of interest rates. So, I agree with you that negative interest rate policy sort of unleashed the impact of our QQE subdued up until January 2016.