- It is not central bank digital currency (CBDC) per se which might act as a game changer in financial markets. What will be key is how central banks accommodate the introduction of CBDC.
- In principle, this accommodation can go very far, to the point where the introduction of CBDC does not affect macroeconomic outcomes.
- But such complete accommodation is unlikely. On the one hand, central banks will want to exploit the new monetary policy options that CBDC opens up; that is, central banks will not choose to fully accommodate.
- On the other hand, the introduction of CBDC increases transparency and this will increase political pressure; as a consequence, central banks will not be able to fully accommodate.
NZZ, April 25, 2019. PDF.
- Modern monetary theory (MMT) is neither a theory, nor modern, nor exclusively monetary.
- I discuss fallacies related to MMT.
- Dynamic inefficiency requires permanent, not transitory, r<g.
- For now, policy makers should rely on common sense rather than MMT.
In a Staff Working Paper, the Bank of England’s Philip Bunn, Alice Pugh, and Chris Yeates discuss how monetary policy easing following the financial crisis affected income and wealth of different age groups.
The authors analyze survey panel data (ONS Wealth and Assets Survey) on households’ characteristics and balance sheet positions. They argue that
the overall effect of monetary policy on standard relative measures of income and wealth inequality has been small. Given the pre-existing disparities in income and wealth, we estimate that the impact on each household varied substantially across the income and wealth distributions in cash terms, but in percentage terms the effects were broadly similar. We estimate that households around retirement age gained the most from the support to wealth, but that support to incomes disproportionately benefited the young. Overall, our results illustrate the importance of taking a broad-based approach to studying the distributional impacts of monetary policy and of considering channels jointly rather than in isolation.
In an NBER working paper, Arvind Krishnamurthy, Stefan Nagel, and Annette Vissing-Jorgensen analyze which components of bond yields were affected by the European Central Bank’s government bond purchasing programs.
Given the institutional restrictions on monetary policy in the Euro area, the ECB had to carefully argue why it intervened in the first place. (To many, the case was obvious; the ECB intervention amounted to quasi-fiscal policy. But an intervention with this objective would not be covered by the rules of the Euro area.) It gave two reasons for the SMP, OMT, and LTRO:
The ECB has publicly stated that these policies reduce redenomination risk, i.e., the risk that the Eurozone might break up and countries redenominate domestic debt into new domestic currencies, and financial market “dysfunctionality,” i.e., segmentation- and illiquidity-induced pricing anomalies.
The authors decompose bond yields into five components: an expectations hypothesis component; a euro-rate term premium; a default risk premium; a redenomination risk premium; and a component due to sovereign bond market segmentation. To identify the non-observable, country-specific components (reflecting default risk, redenomination risk, and sovereign bond market segmentation), the authors use information from asset prices that are differentially exposed to these components.
Specifically, they use the fact that
foreign-law sovereign bonds denominated in US dollars cannot be redenominated through domestic law changes … and redenomination into a new currency should affect all securities issued in a given country under the country’s local law equally.
The authors find that
the default risk premium and sovereign bond segmentation effect appear to have been the dominant channels through which the SMP and the OMT affected sovereign bond yields of Italy and Spain. Redenomination risk may have been present at times and it may have been a third policy channel for the SMP and OMT in the case of Spain and Portugal, but not for Italy. … default risk accounts for 30% of the fall in yields across SMP and OMT for Italy. Segmentation accounts for the other 70%. For Spain, the numbers are 42% (default risk), 15% (redenomination risk) and 43% (segmentation). For Portugal, the numbers are 40% (default risk), 24% (redenomination risk) and 36% (segmentation). For the LTROs, we find that their effect on Spanish bond yields worked almost entirely via the sovereign segmentation channel. We show that the more substantial impact of the LTROs on Spanish sovereign yields than on Italian and Portuguese sovereign yields is consistent with Spanish banks purchasing a larger fraction of outstanding sovereign debt in the months following the introduction of the LTROs.
In a CEPR discussion paper, Christoph Trebesch and Jeromin Zettelmeyer argue that
ECB bond buying had a large impact on the price of short and medium maturity bonds … However, the effects were limited to those sovereign bonds actually bought. We find little evidence for positive effects on market quality, or spillovers to close substitute bonds, CDS markets, or corporate bonds.
A multiple equilibria view of the crisis would probably suggest otherwise.
In an ECB occasional paper, Ulrich Bindseil, Marco Corsi, Benjamin Sahel, and Ad Visser review the European Central Banks’s collateral framework.
From the executive summary, on misconceptions:
… differences e.g. with interbank repo markets: first, central banks are not subject to liquidity risk in the way “normal” market participants are, and can therefore accept less liquid collateral. Second, as the central bank has a zero default probability in its domestic market operations, collateral providers are willing to accept severe haircuts to obtain credit. …
According to the authors the ECB is the most transparent central bank when it comes to its collateral framework. But the latter is also complicated:
However, it is true that the ESCF is relatively broad in terms of the scope of eligible collateral and rather complicated. This is inevitable because of the diversity of financial institutions and markets in the euro area.
In a VoxEU eBook, Refet Gürkaynak and Cédric Tille collect the views of central bank and academic economists on DSGE models. In the introduction to the eBook, Gürkaynak and Tille summarize these views as follows:
… there is agreement on the place of DSGE models in policy analysis. All see these models as part of the policymaker tool kit, while understanding their limitations and perceiving a similar road ahead.
On VoxEU, Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren Weber argue that long-run money demand in many countries is rather stable.
… using a specific, narrow monetary aggregate, M1, we study a dataset comprising 32 countries since the mid-19th century (Benati et al. 2016). The main finding of this large-scale investigation is that, contrary to conventional wisdom, in most cases statistical tests do identify with high confidence a long-run equilibrium relationship between either M1 velocity and a short-term interest rate, or M1, GDP, and a short rate – that is, a long-run money demand.
The Economist reports that implementation gradually changes:
[T]he way in which the People’s Bank of China conducts monetary policy is changing. It is beginning to look a little more like central banks in developed economies as it shifts towards liberalised interest rates. Rather than simply ordering banks to set specific lending or deposit rates—the focus for many years in China—it is altering the monetary environment around them. China does not yet have an equivalent of the federal-funds rate in America or the refinancing rate in Europe, but it has a few candidates for its new benchmark interest rate. The seven-day bond-repurchase rate, which influences banks’ funding costs, is in pole position.
There is also an element of political intrigue in this transition to a more mature monetary framework. The Chinese central bank sits under the State Council, or cabinet, which has the final say over lending and deposit rates as well as other big policy decisions. Repo rates, by contrast, are seen as sufficiently abstruse for the central bank to decide on its own when it wants to change them.
In the NZZ, Kjell Nyborg questions whether the collateral values of the securities the ECB accepts in monetary policy operations reflect market values. He argues that the valuation is discretionary and politicized.
Meine Analyse macht deutlich, dass der Besicherungsrahmen in der Euro-Zone in unterschiedlicher Ausprägung unter all diesen Problemen leidet. Das öffentliche Verzeichnis der zulässigen notenbankfähigen Sicherheiten enthält 30 000 bis 40 000 verschiedene Wertpapiere, von Staatsanleihen bis hin zu unbesicherten Bankanleihen und forderungsbesicherten Wertpapieren (Asset-Backed Securities). Die überwiegende Mehrheit dieser Wertpapiere hat keinen Marktpreis. Ungefähr ein Drittel all dieser Sicherheiten wird in nichtregulierten Märkten gehandelt. Zudem können Banken nichtmarktfähige Anlagen und Wertpapiere mit «privaten Ratings» verwenden, die nicht im öffentlichen Verzeichnis sind. Daher basieren die Werte der Sicherheiten mehrheitlich auf Modell- statt auf Marktpreisen. Interessanterweise ziehen Banken es vor, Sicherheiten zu benutzen, bei denen häufiger theoretische Preise verwendet werden. Generell tendiert die Besicherungspolitik der Euro-Zone zu risikoreichen und illiquiden Sicherheiten. Die untergeordnete Rolle des Marktes sieht man auch an der Häufigkeit, mit welcher die Sicherheitsabschläge für die Repo-Geschäfte des Euro-Systems aktualisiert werden: Dies geschieht lediglich alle drei bis vier Jahre.
Im Kern des Geldsystems in der Euro-Zone gibt es somit wenig Spielraum für Marktkräfte oder Marktdisziplin. Insgesamt kann die Besicherungspolitik des Euro-Systems als expansiv beschrieben werden. Die Liste notenbankfähiger Sicherheiten ist äusserst umfangreich und oft auf die «Bedürfnisse» von Banken in verschiedenen Ländern zugeschnitten. Sicherheiten können, zum Beispiel, durch Staatsgarantien aufgewertet werden. … Weil es im Kern des Euro-Geldsystems an Marktkräften und Marktdisziplin fehlt, entsteht ein Vakuum, das von anderen Kräften, wie Rating-Agenturen und der Politik, aufgefüllt wird.
… Ich dokumentiere, dass DBRS eine ausschlaggebende Rolle innehatte, indem sie über eine lange Zeit hinweg Italien und Spanien ein Rating von A– und Portugal ein solches von BBB– gab. Das hob den Wert der in diesen Ländern begebenen Sicherheiten um ungefähr bis 200 Mrd. € an und kann als unterstützende Massnahme für indirekte Bail-outs interpretiert werden.
Im Dezember 2011 und Februar 2012 hat die EZB eine ihrer wichtigsten geldpolitischen Massnahmen vor dem Beginn des Quantitative Easing implementiert. … Um aus dieser Möglichkeit Vorteil zu schlagen, hat die italienische Regierung gleichzeitig eine präzedenzlose Anzahl von Garantien für Bankanleihen mit niedrigem oder gar keinem Rating gesprochen. Damit erhöhte sie deren Besicherungswert. Darüber hinaus hat die EZB mehr als 10 000 unbesicherte, auf nichtregulierten Märkten gehandelte Bankanleihen der öffentlichen Liste notenbankfähiger Sicherheiten hinzugefügt, obwohl der aggregierte Wert notenbankfähiger Sicherheiten die Nachfrage von Banken nach Zentralbankgeld schon bei weitem überstieg.
In the 18th Geneva Report on the World Economy, Laurence Ball, Joseph Gagnon, Patrick Honohan and Signe Krogstrup ask whether “central banks can do [more] to provide stimulus when rates are near zero; and … whether policies exist that would lessen future constraints from the lower bound.”
They are optimistic and argue that the unconventional policies of recent years can be extended: “[I]t is likely that rates could go somewhat further than what has been done so far without adverse consequences” and “[m]ore stimulus can be provided if policymakers increase the scale of quantitative easing, and if they expand the range of assets they purchase to include risky assets such as equity.” While the authors concede that QE might have negative side effects they argue that the benefits are worth the costs.
To relax the zero lower bound constraint in the future, Ball, Gagnon, Honohan and Krogstrup argue in favor of a higher inflation target. They view cashless societies as not imminent but possible.
In a blog post, Stephen Williamson argues that the US labor market is doing just fine.
Given recent productivity growth, and the prospects for employment growth, output growth is going to be low. I’ll say 1.0%-2.0%. And that’s if nothing extraordinary happens.
Though we can expect poor performance – low output and employment growth – relative to post-WWII time series for the United States, there is nothing currently in sight that represents an inefficiency that monetary policy could correct. That is, we should expect the labor market to remain tight, by conventional measures.
In the Richmond Fed’s Econ Focus, Eric Leeper explains his views.
- Disparate confounding dynamics and simple policy rules:
My view is that central banks have put far too many resources into understanding tiny fluctuations and too few resources into the things that actually matter. …
Something like the basic Taylor rule doesn’t really serve as a useful litmus test for what policy is doing in the face of these DCDs, so it’s a little bizarre to me that a lot of central banks routinely calculate what the path of the interest rate would be with a simple Taylor rule as if that’s a useful benchmark. It’s not obvious to me what that’s a benchmark for.
- Active/passive policy regimes, the fiscal theory of the price level and whether current or previous policy mixes are or were characterized by active fiscal policy:
Now, how all of [current policy] ties into the active/passive framework is really an open question. A lot of it depends on what you think is going to happen to the Fed’s balance sheet.
… the recovery from the Great Depression in 1933 when Roosevelt took the United States off the gold standard. Going off the gold standard converted government debt from effectively real debt to nominal debt because the price level under the gold standard was beyond the control of the government. At the same time, the fiscal actions Roosevelt undertook were what nowadays we would call an unbacked fiscal expansion. … This is like a fiscal rule that says the government will run deficits until the price level recovers to some pre-depression level. And the Fed was just keeping the interest rate flat. So it looked a lot like passive monetary/ active fiscal.
- Walls between monetary and fiscal policy:
The thing is, there’s not a lot of theoretical justification for creating these walls. What we’re finding more and more is that there’s always some role in optimal policy for using surprise inflation to revalue debt and bond prices, so long as there is some maturity to government debt. … maybe it is a slippery slope once you’re in the political realm. But from an academic perspective, if your objective is to arrive at a rule that would be mechanically followed by a central bank, then there’s no harm in having fiscal variables enter that rule.
The winners and losers of the current monetary environment are not that easy to identify. Investors holding long-term, non-indexed debt gain as unexpectedly low inflation shifts wealth from borrowers to lenders. Governments suffer from increased real debt burdens and reduced revenue due to effectively lower capital income tax rates. Policies that succeed in affecting the real exchange rate entail redistribution.
A conference at the University of Chicago’s Becker Friedman Institute addressed the status of the Fiscal Theory of the Price Level and the theory’s implications for current policy. Slides and papers are available on the conference website. Given that the conference was meant to resuscitate research on the FTPL and that the participants were selected accordingly, many contributions appear rather mainstream.
Chris Sims worries about indeterminacy of the price level if monetary policy is constrained by the ZLB and fiscal policy is passive.
The key thing here is that the central bank determines prices and inflation without any fiscal support. If the idea you got from the FTPL is that fiscal policy is necessary to determine the price level and inflation, that’s not correct. …
So, the conclusions are:
- FTPL forces us to think seriously about fiscal/monetary interaction, and that’s very important. But fiscal support is not necessary for monetary policy to work, nor is it useful to think of fiscal policy determining inflation on its own – the central bank can indeed be independent.
- Fiscal/monetary interaction becomes really important when we start thinking about the liquidity properties of government debt.
- Helicopter drops? Forget it. This is not some cure-all for a low-inflation problem.
- QE can be harmful, as it soaks up useful collateral and replaces it with inferior assets.
- Neo-Fisherian denial is not good for you. Central banks that want to increase inflation need to increase nominal interest rates.
John Cochrane argues that to get the cyclical properties of inflation “right” one should focus on the discount factor in the core FTPL equation, not the primary government surplus. The discount factor might also be affected by monetary policy. See also his blog post.
Harald Uhlig remains very skeptical and points to the lack of evidence favoring the FTPL. On his first slide, he asks:
- What does FTPL want to be?
– A theory that can be consistent with the data? OK
– An equation needed to complete a system? OK
– A theoretical or extreme possibility? OK
– A set of predictions, which occasionally work in exotic circumstances (“Brazil”)? PERHAPS
– A set of predictions, which help often (“Taylor coeff < 1”)? ?
– A useful framework for practitioners? ?
– The miracle cure for the failures of other inflation theories? ?
– A framework for the key interplay of fiscal and monetary policy? ?
- Where is the “smoking gun”? What set of facts “scream” FTPL? Specific predictions?
- Why is sovereign default off the table? Sure, a central bank can accommodate by inflating away debt … is that all?
- The US, Japan, the Eurozone have a near-deflation problem (is it?). Do you advocate “irresponsible” fiscal policies to solve this?
- What advice would you give the sunspot-branch of macro?
In his blog, Ben Bernanke discusses the merits of “helicopter drops” as a monetary policy tool.
[A] “helicopter drop” of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.
… the Fed credits the Treasury … in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.
… it should influence the economy through a number of channels, making it extremely likely to be effective—even if existing government debt is already high and/or interest rates are zero or negative. … the channels would include:
- the direct effects of the public works spending on GDP, jobs, and income;
- the increase in household income from the rebate, which should induce greater consumer spending;
- a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and
- the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens.
[Debt financed spending programs lack channels 3 and 4.]
[Helicopter drops are subject to various] practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank.
The public’s perception of central banks has changed during the crisis—and has created expectations that cannot be met. Beyond the buzzwords, the fundamental options for monetary policy makers are the same as always.
In his FT blog, Larry Summers argues for a “quite radical” change in government debt-management. He proposes several lessons:
- “Debt management is too important to leave to Federal debt managers and certainly to leave to the dealer community. … when interest rates are near zero, it has direct implications for monetary and fiscal policy and economic performance … and … financial stability.”
- “… it is fairly crazy for the Fed and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years, with the Fed seeking to shorten outstanding maturities and the Treasury seeking to term them out.”
- “Standard discussions of quantitative easing … are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact on financial markets.”
- In the US, “the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values it was because of signalling effects … not because of the direct effect of Fed purchases.”
- “The standard mantra that federal debt-management policies should seek to minimise government borrowing costs is … wrong and incomplete. … it is risk-adjusted expected costs that should be considered. … it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.”
- “The tax-smoothing aspect, which is central to academic theories of debt policy, is of trivial significance.”
- Rather than providing opportunities for carry trade, “[t]reasury should reverse the trend towards terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short-term instruments without encouraging risky structures such as banks engaged in maturity transformation.”
- “Institutional mechanisms should be found to insure that in the future the Fed and Treasury are not pushing debt durations in opposite directions.”