Category Archives: Liquidity trap

No, Robert E. Hall, that’s not actually the only problem

Matthew Klein has a good post taking down Robert E. Hall’s claim that reserves are lend out. It’s annoying that supposedly intelligent professors and central bank advisors don’t understand how the monetary system works.

He quotes from Hall’s Jackson Hole paper:

Paying an above-market rate on reserves changes the sign of the effect of a portfolio expansion. Under the traditional policy of paying well below market rates on reserves, banks treated excess reserves as hot potatoes. Every economic principles book describes how, when banks collectively hold excess reserves, the banks expand the economy by lending them out. The process stops only when the demand for deposits rises to the point that the excess reserves become required reserves and banks are in equilibrium. That process remains at the heart of our explanation of the primary channel of expansionary monetary policy. With an interest rate on reserves above the market rate, the process operates in the opposite direction: Banks prefer to hold reserves over other assets, risk adjusted. They protect their reserve holdings rather than trying to foist them on other banks. An expansion of reserves contracts the economy.

My emphasis. I don’t know what textbook Hall is reading, but that is so not true. A simple exercise will explain why. Say Bank X think it has too many reserves, and wants to reduce them by buying longer dated US Treasuries. Bank X finds a seller and transfers the money, receiving a bond in return. The seller of the bonds give up the bonds, but receive money in return, which will be deposited somewhere, thus leaving the total amount of reserves unchanged. The only way that the total amount of reserves change is if it is the Federal Reserve selling the bond! If only Hall had read Barnejek’s post from May, we would not have this paragraph.

This shouldn’t be hard. However, Klein is nice to Hall, because he could have kept going. Here’s the next paragraph from Hall’s paper:

The only excuse for not cutting the reserve rate is the belief that short rates would fall and money-market funds would go out of business. This amounts to an accusation that the funds are not smart enough to figure out how to charge their customers for their services. Traditionally, funds imposed charges ranging from 4 to 50 basis points, in the form of deductions from interest paid. A money-market fund using a floating net asset value can simply impose a modest fee, as do conventional stock and bond funds. The SEC may accelerate this move by requiring all money funds to use floating NAVs.

No it is not. Let me give you some reasons and a reading list:

This is just a very quick post. But, errr, tenured professors should now better.

Europe’s problem is monetary, but that’s not all

Lars Christensen has a pretty good post on how Europe’s problems are not fiscal when you compare it to the US. He points out — rightly, I think — that the difference in recovery between the US and Europe is monetary (see Pawelmorski for more). But then there’s this:

The fiscal tightening in the US and the in euro zone have been more or less of the same magnitude over the last four years. So don’t blame ‘austerity’ for the euro zone’s lackluster performance.

But I will, at least partly. The fact that relative difference stems from monetary policy doesn’t exactly mean that the fiscal multiplier is zero now. I think there’s good reason to loosen both where possible.

Denmark’s experience with negative deposit rates

My piece for FT AV can be found here:

FT Alphaville: What the Danish negative rate experience tells us.

What have we learned from Danish negative deposit rates?

I was going to do something on negative rates, but I’m busy and Nordea has written a good primer, and I still think me and Izzy’s post from July last year when they were introduced is pretty good.

Nordea: Denmark Update: Negative interest rates — the Danish experience
FT Alphaville: The ‘natural experiment’ of negative deposits rates in Denmark
St Louis Fed publication: How Low Can You Go? Negative Interest Rates and Investors’ Flight to Safety [hat tip to Toby Nangle]

I might do a little more tomorrow.

The ECB can deal with bank funding problems

Benoît Cœuré from the ECB is usually the best when it comes to writing (and speaking) about the transmission mechanism and market operations. Since he’s responsible for Market Operations; Payments & Market Infrastructure; and Research that’s probably not too weird.

He gave a speech today in Dublin, which concludes:

In the nearer term, how can the impediments to bank funding of SMEs be addressed? In essence, these impediments are of three types: the banks’ own funding conditions, their perception of the credit risk of their clients, and lack of capital. The ECB does not have a magic wand. The central bank cannot compensate for a shortage, or a misallocation of equity. That is something that has to be addressed, in one form or the other, by other stakeholders. Neither can the central bank alter the credit risk of individual borrowers, although governments can have an impact here through reforms that improve the operating environment of those firms – labour and product market regulation for instance. Where the central bank has a direct role, within its mandate, is primarily with respect to bank funding conditions. Indeed, the ECB has taken and will continue to take appropriate measures to ensure that bank funding is not a source of financial fragmentation or an impediment to bank lending. It is reasonable to think that simultaneous action on all three counts, by the relevant stakeholders in each case, would be mutually reinforcing.

While I’m not entirely convinced that the ECB can’t do more than “continue to take appropriate measures to ensure that bank funding is not a source of financial fragmentation,” I guess he might be using ECB speak to tell us they can. Or maybe not. His slides are important, though. They show some very interesting trends (although not really breaking news): Screen Shot 2013 04 11 at 5.04.21 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.29 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.48 PM The ECB can deal with bank funding problems Screen Shot 2013 04 11 at 5.04.59 PM The ECB can deal with bank funding problems

And finally, a chart showing how SMEs fund themselves. This is interesting when thinking about QE in the eurozone as opposed to the EU. The liabilities side of the balance sheet of European corporates is very different:

Screen Shot 2013 04 11 at 5.04.55 PM The ECB can deal with bank funding problems

All slides here.

Two-tiered Europe, redux

Relatively silence from this end as of late, given other commitments (mostly exams.) I did stump upon this paper from the ECB yesterday, though, which elaborates on the discussion of the two-tiered Europe. A couple of nice graphs:

Screen Shot 2013 03 26 at 1.01.11 AM Two tiered Europe, redux

Screen Shot 2013 03 26 at 1.01.13 AM Two tiered Europe, reduxAbstract:

The Euro area economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity. Using detailed data on lending conditions and standards, we analyse how financial fragility has affected the transmission mechanism of the single Euro area monetary policy during the crisis until the end of 2011. The analysis shows that the monetary transmission mechanism has been time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates mainly through the credit channel, both the bank lending and the non-financial borrower balance-sheet channel. Our results suggest that the bank-lending channel has been partly mitigated by the ECB nonstandard monetary policy interventions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SME, we infer that the policies adopted until the end of 2011 might have fallen short of reducing credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress.

Banks’ CA holdings, excess reserves, and recourse at the deposit facility

From the ECB’s monthly bulletin, out yesterday.

Screen Shot 2013 03 15 at 2.19.06 AM Banks CA holdings, excess reserves, and recourse at the deposit facility

The Fed’s exit strategy

I posted on the subject a week ago, and now I’ve come across a paper from the Fed’s research department from September, so it might be worth just posting it here, since it gives a timeline to a possible exit.

First, here’s the abstract:

This paper provides a comprehensive study of the interplay between the Federal Reserve’s balance sheet and overnight interest rates. We model both the supply of and the demand for excess reserves, treating assets of the Federal Reserve as policy tools, and estimate the e ects of conventional and unconventional monetary policy on overnight funding rates. We nd that, in the current environment with quite elevated levels of reserves, the e ect of further monetary policy accommodation on overnight interest rates is limited. Further, assuming a path for removing monetary policy accommodation that is consistent with the FOMC’s exit principles, we project that the federal funds rate increases to 70 basis points, settling in a corridor bracketed by the discount rate and the interest rate on excess reserves, as excess reserves of depository institutions decline to near zero.

And one of the best charts in the paper, showing the floor:

Screen Shot 2013 03 08 at 8.56.12 PM The Feds exit strategy

And the paper. Go to the last page for the exit strategy (click the picture for the paper):

Screen Shot 2013 03 08 at 9.02.11 PM The Feds exit strategy

Savers shouldn’t outperform the economy

Izzy is making a lot of sense over at her tumblr. It concerns the debate that savers are being punished, but given that everything isn’t the same as it always was, people tend to forget a few things:

Here’s the thing. Savings are not supposed to do anything but maintain relative value. They are not supposed to outperform relative to the economy. They are supposed to track it in such a way, that by the time you liquidate the savings, you can still buy the same amount of stuff you could buy when you first created them. The interest earned is supposed to compensate for lost purchasing power.

Good point.

Time to redo those slides

I’m at a lecture in my Corporate Finance class, and I thought I’d share something I’ve come across multiple times in the last year in different classes. Here’s the slide with opportunity cost of capital:

Screen Shot 2013 02 28 at 12.30.33 PM2 Time to redo those slides

So where does one find such a nice return? Well, not in Denmark, where the O/N as of yesterday stood at 0,0079. Here’s the 10-year government bond via Bloomberg:

Screen Shot 2013 02 28 at 12.34.41 PM Time to redo those slides

Then where? As Barnejek suggested on twitter, one might look to such safe havens as Ghana:

Screen Shot 2013 02 28 at 12.40.14 PM Time to redo those slides

[That's the monetary policy rate. The t-bill rates are a bit higher]

I don’t want to pick on any one professor, but assuming we will just return to those rates of return on capital any day now, well — that seems a little outdated. Maybe it’s time to redo the slides.

Unless, of course, opportunity cost of capital is the policy rate of a small West African country.