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.

Comments

Buying the securities lowers long rates further

Except that monetary stimulus RAISES long-term rates.

Like I previously said - if economics professors are reduced to wondering whether printing money is deflationary or not, the only logical conclusion is that an economic education is worse than no education at all.

Oh, and that you don't need to be particularly smart to be a professor.

Why are you here?

Clearly you don't need to be smart to post either, or Daniel wouldn't have been able.

I'm not the one arguing the sky is pink, you morons.

No, you are the one that spends his time reading a blog that is written by people you consider morons. Why is that, exactly?

You aren't arguing anything, but are instead calling people immeasurably smarter than you morons. My guess is that you aren't capable of intelligent argument. I suggest posting on a bodybuilding website instead, they seem a bit more your intellectual peers.

5. None of the above. At negative nominal rates large OMOs are mostly about managing expectations of the future path of the monetary base and/or interest rates.

5b. Negative rates in reality aren't really different from zero rates in most models, and just reflect a small carrying cost of currency. We should just take our zero rate results and slap them on the bottommost attainable negative rate.

Some observations:

1. Open market operations for negative nominal bond yields increase AD through monetarist or Woodfordian channels if market observers believe that these operations are signaling that central bank reaction function has shifted to the easier direction. This is the effect that we are observing right now. Forcing Bundesbank to do crazy OMOs is a powerful signal that doves have won the battle.

2. If these open market operations reduce expected central bank earnings as central bank is buying assets with negative risk premia, what we get is a current redistribution of future seigniorage to private investors. If one believes in Old Keynesian logic, this could provide a stimulus in short run, especially if fiscal authorities are committed to austerity.

3. These open market operations mess up with the optimal mix of liquid assets, creating a shortage of certain classes of liquid media of exchange. Latin American experience with coin shortages in the context of high inflation should persuade us that the size of this effect is not macroeconomically important.

4. When central banks purchase assets with negative risk premia, they are purchasing insurance they do not need, they are creating a distortion in macro insurance markets. This is a negative supply-side effect.

5. Negative effects described in number three and number four are largely offset by the actions of private sector, central banks and fiscal authorities. For example, fiscal authorities will change the maturity structure of government debt to offset the negative effects of negative yield OMOs - this has already happened in the US. Central banks will restore the equilibrium in markets for liquid collateral by starting securities lending programs.

6. First best monetary policy would always select the optimal mix of purchased assets, increasing the size of QE if needed to preserve the same amount of signaling effect.

In a financial system in which you can't transfer currency in size, banks are desperately trying to cut off access to central bank money (shed deposits), and you can't post central bank money as collateral, high quality sovereigns probably are more liquid than 'currency'. Welcome to the Basle version of a safe banking system.

This. Cash is liquid but not secure. Would you accept cash as collateral? The high demand for sovereign bonds is the result of a series of events:

Cypress bank failures resulting in depositors cash being used to pay off creditors.

Greek bank runs. The fact that Europe is even talking to Greece tells me that there is real nervousness about the European banking stability. Either through direct losses or contagion.

The commodity price collapse as well as the shipping bankruptcies are indications that something is finding a bottom. European exports, the northern economies that did reasonably well over the last half decade are all affected.

All the European countries will be going to the bond market for deficit financing. Has any not had to do so over the last half decade? As per the US, the central bank will buy up the years issuance. The bond prices will stay high allowing successful financing operations.

The effect on the economy? Almost none. The governments, banking sector and central bank authorities will be happy, and since the world's economic marbles have been intimately dependent on the decisions of the central banks, the financial system participants will be happy; grateful is probably a better word. Everyone else will be poorer.

Krugman, on his blog, has a post titled Exporting Europe's Stagnation, which demonstrates just how differently he and economists like Cowen see the world and approach economic issues. Krugman first considers how interest rate differentials in Europe (those negative rates in Europe) and the U.S. will affect aggregate demand/GDP here and there and then works backwards to interest rates and money supply, whereas Cowen, Sumner, et al. start and stop with interest rates and money supply. Krugman is from Venus and Cowen, Sumner, et al. are from Mars.

I'm pretty sure that it isn't the Mars family fortune funding chairman and general director Cowen's activities.

And what do you make of Carlos Slim?

And could such a "short" paper also touch upon the concept of applying "mark to market" for the assets acquired by central banks (and the FED) ?

1- As someone mentioned above, there is the expectations channel, which is stimulative.
2- in a world of excess capacity, companies & households (including banks and lenders generally) are losing money on assets already. Non-risk-free assets loans) with credit risk see higher losses; houses and real assets undergo depreciation. When the price of say housing is too high (but effectively fixed), people will consume less - which may take the form of allowing it to depreciate faster. The same goes for any long term real asset.

In other words, investing in a real asset (or an asset with credit risk) at a time of excess capacity may result in a negative return. So, I'd rather invest in something with zero return.

Now, push rates negative to the point where short rates are *more negative* than depreciation (or credit losses) and the demand for safe assets plunges. Note also, a higher inflation target (from #1) erodes the value of safe assets as well.

Don't be fooled by negative nominal yields on safe assets any more than a zero yields on safe assets. Neither is a sign of loose policy, because the equilibrium real rate might be negative due to excess capacity.

Would you be worse off buying a bond that pays minus 2 percent with an expected inflation rate of minus 1 percent, as compared with buying a bond that pays plus 10 percent with an expected inflation rate of 11 percent?

If saving is a form of deferred consumption, isn't the result the same in either case? That is, is what matters the nominal return on investment, or the inflation-adjusted return (well, actually, adjusted for inflation and taxation, if any)? And yet the focus seems to be on the nominal rate.

In either case, if the adjusted ROI is less than zero, you'll be able to buy more today than you'd get when your investment matures (which presumably would stimulate current consumption and discourage saving).

Up to a point, as you might still want to be able to afford food and rent tomorrow, even at the cost of doing without luxuries today.

European QE (at least as it is currently understood) is a hoax. As it is, the ECB cannot possibly find enough Bunds to buy to fill their German quota and Germany has an excellent chance of going into a primary surplus within the next year. A chance which become more excellent as they sell more "debt" which pays interest to the German State. At the same time, the German public is not likely to stand for the idea of QE only for non-Germans. And what will the non-German public say when they figure out that the ECB is effectively paying direct subsidies to the German treasury? And the ECB says this program is going to continue for years to come? Really?

If you want to gain some insight on QE you need to talk to traders and buy-siders. I wouldn't expect to see a decent academic paper on QE and its affects anytime soon.

The simple answer is that central bank purchases of government bonds will raise the price level of assets (in terms of the CB's currency). It's not predictable which assets will appreciate or by how much. Import prices will be increased and exports stimulated as repricing of foreign assets changes FX rates. The relevant channel is the portfolio aka hot potato effect.

Re relative risk premia of bonds vs currency, don't forget IOR, deposit insurance and other regulation of deposits. Reserves are very slightly more liquid than bonds, both of those are much more liquid than banknotes.

However, the *effects* of QE will be studied successfully and frequently.

Gods, you're arrogant.

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