Will the major central banks evolve into mega-hedge funds?

by on June 13, 2014 at 3:44 am in Current Affairs, Economics | Permalink

Here is the latest from Japan:

Bank of Japan officials are considering maintaining a large balance sheet for the central bank even after it achieves its inflation target, reducing the risk of a surge in long-term bond yields, sources said.

Under the potential strategy, the BOJ would use cash from maturing securities in its portfolio to buy long-term government debt, the sources said, asking not to be named as the talks are private. Gov. Haruhiko Kuroda and his colleagues have yet to meet their inflation target, and pledge to continue asset purchases until consumer prices are rising at a 2 percent pace.

The possibility of permanently large balance sheets — in Japan’s case, now amounting to more than half the size of the economy — may become a global legacy of unprecedented stimulus measures. The BOJ discussions parallel preparations at the U.S. Federal Reserve to avoid an exit strategy of asset sales.

“There’s no need for the BOJ balance sheet to go back to where it was,” said Hiromichi Shirakawa, chief Japan economist at Credit Suisse Group AG in Tokyo and a former BOJ official. “It’s a realistic approach to keep the size of the balance sheet large for a while to avoid a spike in yields.”

Any abrupt end to government bond purchases by the BOJ could send borrowing costs soaring, because the bank currently purchases the equivalent of about 70 percent of the new securities issued.

Were not these exit strategies supposed to be easy and painless?  Maybe they are, except having no exit strategy is all the more easy and painless.  In their shoes, I would not do differently but my level of unease with this situation continues to increase.

There is more here, via www.macrodigest.com.  And here is a new VoxEU piece on what we know about the macroeconomic effects of asset purchases.  And here is Noah Smith mounting a defense of Abe.

Daniel June 13, 2014 at 4:29 am

I love it how people are looking for reasons to worry about something.

First, there was inflation. It was definitely coming.

Then, it was financial stability. Low interest rates definitely lead to financial instability.

Now it’s the balance sheets. Surely their size must be bad. Because … well, just because.

If this is the outcome of an economics education, an economics education is worse than useless.

dan1111 June 13, 2014 at 4:48 am

Sometimes stuff that people worry about ends up happening. Sometimes bad stuff doesn’t happen because people worry about it. Sometimes people worry and are wrong. Sometimes people don’t worry about things that end up being bad.

Predicting the future is hard. It doesn’t follow that trying to understand what is going on and predict the consequences (whether through economics or otherwise) is a bad thing.

Daniel June 13, 2014 at 5:26 am

And sometimes people write nonsense on the internet.

Z June 13, 2014 at 10:26 am

And some people are too dumb to know when they have been insulted. My goodness.

8 June 13, 2014 at 4:56 am

That’s just another reason to worry: the central bankers have economics educations.

Daniel June 13, 2014 at 5:26 am

You are correct. Money is too important to be left to the central bankers.

rayward June 13, 2014 at 7:48 am

I agree with both Dan and Daniel; I’m no economist, but I do have two hands. I’ll add one to Daniel’s list: volatility, which was considered a bad thing until recently when we’ve been told by worriers that the absence of volatility is a bad thing. Low interest rates cause volatility; no, low interest rates cause the absence of volatility. Up is down, down is up.

BC June 13, 2014 at 8:46 am

It seems to me that the worrying is not the “outcome of an economics education” but the result of not applying it.

Doug June 13, 2014 at 5:33 am

One advantage a central bank is that it can actually execute a martingale. Whereas private investors have finite wealth, the central bank in a given currency zone has access to infinite wealth through the power of the printing press. This means there’s a certain class of investment opportunities, where expected return is positive but potential losses have very fat left tails, which only the central bank can capitalize on.

The Anti-Gnostic June 13, 2014 at 7:51 am

“Infinite wealth?” Then what the hell, abolish taxes and just print all the money the government needs.

C June 13, 2014 at 8:50 am

This strategy has actually been pretty effective for large corporations.

The Anti-Gnostic June 13, 2014 at 9:19 am

I remember when GM was floating billions in bond issues and paying $2/sh. dividends. When the inevitable happened, they just gave the bill to Uncle Sugar.

Yancey Ward June 16, 2014 at 9:58 am

Whereas private investors have finite wealth, the central bank in a given currency zone has access to infinite wealth through the power of the printing press.

Captured in this one sentence is the central fallacy that will eventually undo every central bank- that there is no limit to the power of central bank.

andrew' June 13, 2014 at 6:41 am

I still can’t hire a babysitter without worrying I am afoul of some cockamamie tax law that the feds can suspend willy nilly, can I?

Point being, have they addressed a single labor market friction not counting when they’ve worsened them?

Monetary policy may be pushing on a hammock.

dead serious June 13, 2014 at 7:38 am

Just don’t run for political office and you should be good to go.

Andrew' June 13, 2014 at 9:55 am

That kind of misses the point. The point is that I could not really create a babysitting corporation either (and no, I’m not just concerned about babysitting, it is an illustration). That the bar is so low (“just don’t run for office”) shows how much unseen damage this stuff does. It is probably why things like Uber exist. We had to wait until the technology allowed us to bypass artificially-ZMP employment by having people do these things for themselves…like babysitting.

Daniel June 13, 2014 at 10:39 am

When all you have is a hammer, everything looks like a nail.

What does monetary policy have to do with inefficiens in the labour market ?

Yancey Ward June 16, 2014 at 10:00 am

Do you even read the arguments of inflationists?

Effem June 13, 2014 at 10:53 am

Corporate profits are at a RECORD high. I find it hard to believe “frictions” are a big issue. It’s not as though corporations are struggling to find the money to hire. They simply don’t want to.

Daniel June 13, 2014 at 1:17 pm

You don’t really get this whole “sticky wages” thing, do you ?

Effem June 13, 2014 at 3:07 pm

You don’t get it. Correct me if i’m wrong but here is the theory: wages are sticky, so if inflation rises real wages fall, which means there is more profit potential from hiring workers, which means more workers get hired. Well, the profits are there..in record amounts….but the hiring is not.

Cliff June 13, 2014 at 3:55 pm

Because wages are too high. No one turns down more profit if it’s available

Daniel June 13, 2014 at 5:03 pm

Cliff has already answered you, but I’ll add another thing – you do realize unemployment has fallen, right ?

It’s not at pre-recession levels yet, but that’s because the Fed isn’t doing their job properly – namely, making sure there’s enough aggregate demand. That is to say, they’re not printing enough money.

ThomasH June 13, 2014 at 7:15 am

Is this anything more than saying that BOJ or the Fed will not sell off its balance sheet unless it’s necessary to control inflation? Sounds like conventional monetary policy to me. QE is also pretty conventional once central banks got over (Is the ECB over it yet?) the self imposed “bound” of only purchasing short term assets.

BC June 13, 2014 at 8:59 am

I had similar thoughts. Isn’t central bank “balance sheet” just another term for “supply of base money”? The “balance sheet”, or money supply, was increased due to surging money demand. When money demand falls, an “exit” strategy can be used to decrease money supply. If money demand does not fall, then why decrease money supply? Why override the market’s demand for base money with some artificial government-imposed quantity?

Daniel June 13, 2014 at 10:40 am

Because the Very Serious People need to worry about something. To show that they care. Or something.

T. Shaw June 13, 2014 at 8:21 am

More like mega-ponzi schemes. Only thing: Ponzi couldn’t “print” money . . .

David Beckworth June 13, 2014 at 9:28 am

This completely misses the point that only monetary injections expected to be permanent will have a meaningful effect. The BOJ already implied its balance sheet would be permanently larger, if needed, when it committed to a higher inflation rate. Focusing on yields is a side show.

Milton Friedman would approve of BOJ’s larger balance sheet: http://macromarketmusings.blogspot.fr/2013/07/abenomics-as-fulfillment-of-milton.html

F.F. Wiley June 13, 2014 at 2:30 pm

Friedman also predicted soaring inflation in every year from 1983 to 1986 and a recession in 1984. If he thought that the BoJ could trick everyone into spending more merely by announcing that their balance sheet changes are permanent (and with no payback further down the road), then I’d say he was dead wrong again.

Since the term “speculative” pops on this site all the time, someday I’d love to see an acknowledgement that the whole idea behind a permanent monetary injection having magical effects is as “speculative” as they come.

Effem June 13, 2014 at 10:51 am

Where are all the free-market lovers? You now have bureaucrats making massive financial bets. What could go wrong?

The Anti-Gnostic June 13, 2014 at 11:01 am

Major difference: when a free market actor makes a bet he has to come up with the money himself. He can’t just collect taxes or print it. The risk remains non-systemic.

Effem June 13, 2014 at 11:02 am

Uh, Congress could easily change the law to be able to print its own funds instead of having to borrow. And if that were to happen then you’d be comfortable with Congress making massive financial bets?!

The Anti-Gnostic June 13, 2014 at 12:17 pm

No?! I wouldn’t?! Because when you can just print or tax, non-systemic risk becomes systemic?!

mulp June 13, 2014 at 3:30 pm

“the macroeconomic effects of asset purchases”

I see all those “assets” as liabilities.

When I grew up, assets were real things that lasted a long time and provided some return over that period that exceeded the face price of the asset and in addition had residual value even at end of useful life.

Since 1980, the unchaining of finance from government enforced reality, and government deciding that borrowing money you never intend to repay to create a crisis that would stop all lending to government, “asset” represent past spending with no residual value at all – pure past consumption.

Banks extended this to mortgages, funding past consumption with mortgages on assets that had inflated prices even as the building were decaying in regions of economic decline which was eroding the monopoly price of the land. Draw the Detroit city line between two plots of land, and one has a lower price than the other because the deed to the Detroit property is currently a bigger liability than the one outside.

The current efforts are to destroy the value of the “assets” which are the liabilities of Detroit so the deed to land inside of Detroit will be unburdened from the liability so the monopoly of the deed will reap huge price gains. The value of the land is unchanged.

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