Open market operations for negative nominal yield bonds

There are lots of those such securities these days, so what happens when a central bank buys up some with monetary reserves?  An email from Scott Sumner prompted me to address this question more directly than my mere mention from yesterday.  I see a few scenarios, none of which satisfy me:

1. Buying the securities lowers long rates further and depresses the value of the currency, which is broadly stimulatory.  Arguably this would follow from a Keynesian model.

2. Currency determines the price level, not bonds, as in Fama (1980).  Alternatively, old-style monetarists might believe that something like M2 determines the price level.  Either way, we can expect the OMO to raise the price level and perhaps depress the exchange rate as well.

3. Portfolio theory means that the lower rate (indeed negative rate) instruments must have higher liquidity premia.  Buying up higher liquidity instruments with lower liquidity instruments (i.e., currency) ought to be contractionary.  Don’t be fooled by Fama and the monetarists, in a world of credit it is all about liquidity in the broad sense and that in this scenario is going down.

My intuitions are closest to number three, but I am not trying to claim that is being verified empirically.  And oh, there is also #4:

4. If nominal rates are negative, all the action is in the risk premium.  And the effect of this asset swap on the risk premium is????

I would gladly link to the first person to write a serious short paper on all of this.


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