BlogSpot - Negative yields and the zero-lower bound
The Anomaly of Negative yields?
Negative yields are increasingly prominent in Europe. Jeremie Cohen-Setton (Bruegel) reflects in a blogspot on how negative yields on some government and corporate bonds, as illustrated by Matthew Yglesias, are raising questions about our understanding of the ZLB constraint—i.e., the facts that nominal interest rates could not fall below 0 (Evan Soltas), because holding cash guarantees a 0-return (Miles Kimball), or, if holding costs are taken into account, negative but close to 0 (JP Koning). Cohen-Setton notes that close to $2 trillion dollars of European debt carries negative nominal yields. And Barclays, hat-tip FT Alphaville, presents an illustrative chart that shows that across all European investment grade credit, the proportion of issuance yielding more than 2 per cent has shrunk to just 5 per cent. Tyler Durden (Zerohedge) writes that negative interest rates are a natural consequence of the rampant money creation undertaken by central banks, inducing speculative behavior in search of decent investment returns.
Paul Krugman argues that the effective lower bound is the return on cash held by people who would otherwise be holding that government debt—the cost of storage. Krugman insists that once interest rates on safe assets are zero or lower, liquidity has no opportunity cost—this is the liquidity trap. Cecchetti and Schoenholtz argue that this can be very low.
Cohen-Setton reviews the theory of negative interest rates. For Brad Delong, in the late 19th century, the German economist Silvio Gesell (David Kehoane) argued for a tax on holding money to avoid money hoarding in times of financial stress. According to Gavyn Davies, the Swiss and Danish central banks are testing where the effective lower bound on interest rates really lies by pushing policy interest rates more deeply into negative territory.
The policy mix beyond the ZLB
Using the fiscal lever may be the first line of defense when faced with a liquidity trap. Simon Wren-Lewis, in Mainly Macro, looks at the issue of whether fiscal stimulus is desirable in a liquidity trap. His answers goes step-by-step: first, a fiscal stimulus is needed to deal with a large output gap, then, over the medium-term, austerity will be more effective to deal with high levels of government debt when interest rates are not at the ZLB. The short-term problems associated with high government debt (crowding out through high real interest rates, higher distortionary taxes, the ‘burden on future generations,’ and market perceptions of default risks) are lesser concerns at the ZLB. In another blog entry, Wren-Lewis reminds us that the costs of austerity (about 4 percent of eurozone GDP according to a Vox piece or a paper by Sebastian Gechert, Andrew Hughes Hallett and Ansgar Rannenberg) call for proactive action on the fiscal side: when monetary policy is stuck at the Zero Lower Bound, the main instrument for correcting the output gap is fiscal policy. For Wren-Lewis, the right policy is to get the output gap to zero, so interest rates can rise above the ZLB, and then you deal with the deficit.
The current European framework may hamper the proper policy mix. While Wren-Lewis criticizes European policymakers for failing to adjust to this reality, Carlo Cottarelli (VoxEU) finds that the (otherwise welcome) reinforced emphasis on structural rather than headline deficits is based on underestimated potential output growth estimates, which require, in years of modest growth (but treated as a year of economic boom because of the low potential estimate) faster than normal fiscal adjustments—further damping the role of fiscal policy.
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