Change Observation
So, I have an observation here. Bernanke was VERY clear about how careful they were with even a single word “given” to markets. I assume that has not changed. If Powell doesn’t want negative rates, why change the verbiage from “zero” to “effective” lower bound?
— Randy Woodward (@TheBondFreak) September 24, 2019
The self-described “BondFreak” noticed a shift in Fed vocabulary from “zero bound” to “effective lower bound”.
Why?
Powell Ready to Cut Rates to “Effective Lower Bound” via “Conventional” Policy
A Google search for “effective lower bound” just happened to turn up my own post Powell Ready to Cut Rates to “Effective Lower Bound” via “Conventional” Policy.
Here are the pertinent statements from a speech Powell made on June 4 at a “Conference on Monetary Policy Strategy, Tools, and Communications Practices”.
Emphasis is mine.
While central banks face a challenging environment today, those challenges are not entirely new. In fact, in 1999 the Federal Reserve System hosted a conference titled “Monetary Policy in a Low Inflation Environment.” Conference participants discussed new challenges that were emerging after the then-recent victory over the Great Inflation. They focused on many questions posed by low inflation and, in particular, on what unconventional tools a central bank might use to support the economy if interest rates fell to what we now call the effective lower bound (ELB). Even though the Bank of Japan was grappling with the ELB as the conference met, the issue seemed remote for the United States.
The next time policy rates hit the ELB—and there will be a next time—it will not be a surprise. We are now well aware of the challenges the ELB presents, and we have the painful experience of the Global Financial Crisis and its aftermath to guide us. Our obligation to the public we serve is to take those measures now that will put us in the best position deal with our next encounter with the ELB.
The big difference between then and now is that the federal funds rate was 5.2 percent—which, to underscore the point, put the rate 20 quarter-point rate cuts away from the ELB. Since then, standard estimates of the longer-run normal or neutral rate of interest have declined between 2 and 3 percentage points, and some argue that the effective decline is even larger. The combination of lower real interest rates and low inflation translates into lower nominal rates and a much higher likelihood that rates will fall to the ELB in a downturn.
Why the shift?
I believe the answer is the Fed no longer believes zero is the ELB. So this leads to a different question.
Where the Heck is the ELB?
First, we need a definition.
What’s the Definition of ELB?
Effective Lower Bound is the point beyond which further monetary policy in the same direction is counterproductive.
I propose the Bank of Japan and the ECB are already below ELB. I further propose the ELB can never be negative but it can be well above zero.
Reversal Interest Rate
I happened across an article just the other day on the ELB moving target.
Please consider The Reversal Interest Rate
The “reversal interest rate” is the rate at which accommodative monetary policy “reverses” its intended effect and becomes contractionary for the economy. It occurs when recapitalization gains from duration mismatch are more than offset by decreases in net interest margins, lowering banks’ net worth and tightening its capital constraint. The determinants of the reversal interest rates are (i) banks asset holdings with fixed (non-floating) interest payments, (ii) the strength of the constraints that they face, (iii) the degree of interest rate pass-through to deposit rates, and (iv) the initial capitalization of banks. Furthermore, quantitative easing increases the reversal interest rate and hence should only be employed after interest rate cut is exhausted. Over time the reversal interest rate creeps up, since the capital gains effect fades out as longterm bonds holdings mature while the net interest margin effect does not.
The authors propose the rate can be above or below zero but it gets higher over time especially if QE is involved.
Bank Lending Constraints
In our model, as in reality, the risk-taking ability of the banking sector is constrained by its net worth. If the latter is high enough so that the constraint does not bind, or if capital gains are strong enough to actually increase net worth, then an interest cut generates the boom in lending that the central bank seeks to induce. However, if capital gains are too low to compensate the loss in net interest income, net worth decreases to the point where the constraint binds, limiting banks’ ability to take on risk. At that point, i.e. at the reversal interest rate, any further interest cuts generate a decline in lending though the net-worth feedback. Moreover, an interesting amplification mechanism emerges. As the negative wealth effect further tightens banks’ equity constraint, banks cut back on their credit extension and are forced to increase their safe asset holdings. As safe assets yield lower returns, banks’ profits decline even more, forcing banks to substitute out of risky loans into safe assets, which in turn lowers their profit, and so on.
Bingo
Huge Failure Already
I discussed lending constraints the other day (and many time priors) in ECB’s New Interest Rate Policy “As Long As It Takes” Huge Failure Already
Banks Lend Under Two Conditions
- They are not capital impaired
- They believe they have good credit risks
If either condition is false, then banks don’t lend.
Negative interest rates did not induce either Japanese or European banks to lend.
What’s Going On?
Either European banks are more capital impaired than the ECB wants everyone to believe, or banks believe there are few good credit risks worth taking.
Take your pick. I expect both are true.
Stealth Recapitalization
We then uncover the determinants of the reversal interest rate in our baseline model. The reversal interest rate depends on bank assets interest rate exposure, the tightness of financial regulation, as well as the market structure of the banking sector. If banks hold more longterm bonds and mortgages with fixed interest, the “stealth recapitalization” effect due to an interest rate cut is more pronounced, and the reversal interest rate is lower. Stricter capital requirements rise the reversal interest rate. Lower market power, which decreases profits, also generates a higher reversal interest rate. For example, in a negative interest rate environment, innovations that allow depositors to substitute bank accounts for cash more easily hurt the banks’ margins and raise the reversal interest rate; if such innovation occurs below the reversal interest rate, it directly feeds back into lower lending.
The article mentions “stealth recapitalization” of banks. I have discussed that many times recently but in a different context.
The Fed pays interest on excess reserves but the ECB charges them. Whereas the Fed gave free money to banks, the ECB charged the banks for excess reserves it forced into the system.
Negative Interest Rates Are Social Political Poison
In contrast to the authors, I do not believe negative interest rate policy can ever work as it violates basis economic principles on time preference and the time value of money.
Moreover, a dive below the ELB supports the position I presented on September 23: Negative Interest Rates Are Social Political Poison
ELB Comments
- I like the notion of ELB, or Reversal rate if you prefer.
- I do not believe it can ever be below zero but accept the notion it can be higher.
- It is not fixed
- It varies bank-by-bank and changes over time
Chasing Tail Madness
Searching for the ELB is like chasing tails.
It’s only by accident can a central bank catch the tail. But even if it does catch the tail, the tail can still move. Further efforts to re-catch the tail are as likely as not to be in the wrong direction.
With that, let’s return to the BondFreak’s question. Why the word change?
Perhaps the Fed is aware the ECB is on the wrong course, negative rates are counterproductive, or the ELB just might be above zero.
Perhaps it’s meaningless happenstance.
Deeper Down the Rabbit Hole
Yesterday, I noted Draghi Open to MMT and a People’s QE
Every attempt to fix the perceived problem of “too low inflation” goes deeper and deeper down the rabbit hole.
It’s economic madness, yet, here we are.
The solution is to let the free market set interest rates rather than a tail-chasing consortium of economic wizards who have never spotted a bubble or a recession in real time.
Of, course, we also need to get rid of central banks and fractional reserve lending.
Got Gold?
Unfortunately, central banks will not vote to abolish themselves. It’s also certain that government efforts to take direct control of money will be even worse than the actions of central banks.
A position is gold is the best counter to monetary policy madness.
Mike “Mish” Shedlock
On average, the US economy is growing pretty nicely. On average. But if you stayed awake during your statistics classes, you may have heard the story about the old man in his kitchen. One foot in the oven, burning. One foot in the freezer, freezing. But on average, his feet are quite comfortable.
And so goes the US economy. Areas dependent on ever increasing piles of debt to cover continuous losses are in deep trouble. Areas that limited debt levels are doing quite well. On average the whole country is quite comfortable.
The Fed, as a central planning vehicle, has no tools to handle this bimodal distribution…. oh crap, I am writing this on a blog where many readers do not have the math background to understand what bi-modal means. Well, most of them are in the bankrupt category anyhow.
Powell has no way to fix the debt problem. Its not a money supply issue, its a debt issue. And lowering interest rates will only encourage the healthy parts of the economy to further side-step national banks. Local banks and local credit unions are doing MUCH better than the money center banks.
Negative rates won’t happen in the USA for the same reason they didn’t stick in Japan. NIRP neutered Japan’s money center banks, which made the Bank of Japan impotent as well.
Central planners in the USA are doing the same dumb things, so they will get the same dumb results. Deal with it 🙂
You can pretend the economy is “booming”,but the reality is the economy is far too weak for far too long for even ZIRP,which means NIRP and around the clock triage level money printing is the future…Fed is printing half a trillion a month desperate to keep the banks from complete collapse,that’s the reality of the situation….deal with it!
He could mean they won’t go negative or close to zero like they did before. From everything I’ve read about the current Fed chair, he was against going as low as they did during the financial crisis. I suspect rate cuts are going to come to an end quicker than people think and banks, bonds and other private investors will have to take a bath on their investments that reset in 2020 or have notes come due. Bondholders at WeWork aren’t getting paid back. There are many companies like this.
It’s impossible for our logic minds to accept this weird, new reality. It makes me so angry, not just because it’s unjust, unfair and counter-logical…but because it doesn’t work. They’ve tried it for 10 years, meanwhile the inequality has never been greater and the bubble just keeps growing. Let it pop, I say!
I read that a truckload of Tesla burst into flames in Nevada. They were en route to be exported from the East coast to Europe. There was also that Tesla that burst into flames while parked in a Chinese parking garage. And there were several more incidents of Tesla on “auto pilot” that crashed… one kept driving after a crash, and then crashed a second time. A police cruiser Tesla lost a suspect they were chasing because the Tesla just stopped working (but it did not burst into flames! So there is that!)
Last week, Tesla pissed off Germany by running a heavy diesel generator to charge the batteries of the non-production Tesla that failed to make it all the way around the Nurburg Ring.
Uber loses money even though it doesn’t pay the cost of wear and tear on driver vehicles.
Netflix is losing money, even more so because of its new production division.
Amazon has some bright spots, but mostly it operates at break even or less. Too many of its products are made in China, which causes quality control problems even before the trade dispute (which was happening before Trump and will continue after Trump) Two thirds of Amazon’s profits come from AWS (web services) and it uses those profits to put mom and pop shops out of business.
Knowing San Fransisco has all sorts of problems with rats, needles, homelessness etc — imagine what things would be like if not for IPOs of money losing companies? Given how bankrupt the state of California is now, imagine how it would be with less IPO related capital gains taxes?
The US economy is both much stronger than advertised (in some areas) and also more bankrupt than advertised (in SF and DC and other places). A rebalancing is long over-due.
The EU doesn’t have a rebalance — it is one size fits all run by central planners. The whole thing is bankrupt.
Agree however there are more productive companies than not in tech. The problem is WeWork, Uber, Tesla and others you mention are skewing the financial picture. FWIW, the boom in jobs over the last decade has been in healthcare. This is not a productive industry at a baseline. It reminds me of the real estate boom in the 2000s. Insurance and health care companies are doing nothing to bring cost down while hiring more people. They just increase their charges to the end consumer and companies. This isn’t like the 90s boom that was like the industrial revolution. Health-care, like real estate, is not an industry that can drive productivity growth long-term. FIRE and health-care are necessary evils that the productive part of the economy has to deal with but at a baseline, they can’t be growth drivers forever as we saw in the 00s.
“In Search of the Effective Lower Bound”
In search of the ineffective lower bound.
Japan has been trying to push rates negative for decades. It doesn’t work. Cash, gold and general house clutter all pay 0%, so there is never a reason to accept negative rates.
Fill your pantry with non-perishable food items — all of which yields 0%.
Buy scrap metal — it yields 0% also. The list if things one can buy that yield nothing is almost infinite. Why would anyone accept less than nothing?
Individuals don’t accept it in Japan. JGBs are essentially sold at gun point (entities like Japan’s post office are required to buy them by law). No reason to think anyone will voluntarily buy negative yielding Treasuries either. The ECB buying euro-trash isn’t the same as European citizens buying it.
Meanwhile, pensioners really have nothing better to do with themselves but vote out the party that tries to steal their savings. How many prime ministers has Japan gone through since 1990? The LDP lost an election for the first time ever.
The Fed can dance and blow lots of smoke, but they aren’t fooling anyone with their pseudo intellectualism. There is no reason for negative rates ever. It is a sign that a government is failing.
So it’s up to us voters, worldwide, to hold our politicians accountable, make the discussion mainstream and protest. Or…we could all wear pussyhats and scream aimlessly at the sky!
It WAS up to you voters. But you allowed Brussels to run the EU into the ground. And more recently you allowed Brussels to appoint Christine Lagarde to manage your money.
You (everyone in the EU) are way beyond screwed. I would suggest you stock up on toilet paper (it yields 0%, better than the banks are paying!). In socialist countries, basic necessities like toilet paper goes into short supply.
Potato famine history not withstanding, Ireland is more self sufficient in foodstuffs than a lot of the EU. Food “yields” negative rates (it goes bad after a time) — so I would put your money in non-perishables that Brussels won’t try to confiscate to save themselves. Sorry to inform you this late, but you are expendable. The bureaucracy must live as long as it can
Well Bob,
I voted against the EU, in both referenda.
The people didn’t want it and still, we got it.
The same thing happened to us in the USA when that b!tch Pelosi shoved Obamacare down our throats
At this point, how much of one’s portfolio should be in gold is a question not easily answered. Conventional apportionment theory really does not address today’s high-price/shrinking yield, near-zero interest rates, and excessive public/private debt, and the likely outcomes as economic growth slows.
The above question, in my mind, resolves to three scenarios. What is the probability of a stable/slow recovery relative to a pessimistic Great Implosion, or the optimistic rapid return to normative conditions (no substantial recession)? The higher the probability of a G-I, the higher the proportion of gold (for insurance) and cash (for bargain hunting).
The instigating factor(s) of the G-I could be any number of things. Bankruptcy of a major bank/company (GE anyone) could be enough for panic to set in. Once the lemmings start to run, they won’t stop at the cliff.
“If Powell doesn’t want negative rates, why change the verbiage from “zero” to “effective” lower bound?”
…
Ha. I chided Powell for painting himself in the corner re: negative rates. I guess someone clued him in that Federal Reserve FOLLOWS the market … does not lead.
I kindof suspect that an ELB can be negative in a Pol Pot scenario, where you can buy a bullet, or take a machete chop to the neck. At such times, investment strategy might not make good sense.
I wonder, though, if ELB could be negative in any other situation, or if the announcement of a negative ELB should be taken as a warning of intent.
[An ELB could dive negative for a short time depending on peoples’ reaction rates — but I don’t think we’re talking about that here.]
Trump’s Economic Program Has Left Most Americans Worse Off
His tax cuts and tariffs are driving up prices and lowering wages. True? False? Convince me
link to washingtonmonthly.com
I think Trump is a small part of it; but not even close to the lion’s share of the problem. If you look at wages, they have been lowering long before Trump; if you look at prices, they have been going up since 2008 at least; and in fact far longer than that.
I’ve been seeing increased suicides; increased mental illness; increased stress far longer than Trump.
I’d say that when the curve is exponential before and after, you’re dealing with a fundamental structural flaw. It would be safer to say that the swamp is driving wages down, prices up. But even that isn’t the truth.
I’d say the truth is closer to the idea that a proper government gives access to power through legitimate means, then ties down those who access it through those means. In our own government’s case, that was not done to the power of money; so the government has been disrupted; and with it, the economy.
The FED funds rate will never go negative. If every other central banks pushes rates negative, we should keep ours at say 1% and it will allow us to run huge deficits forever. The line for newly issued TBills will be enormous.
1% with inflation >=2%.
Imagine a world.
Where banks were not bailed out.
Where QE never happened.
Where TARP never passed.
Where Jon Corzine was sent to jail. Where bankers went to jail.
Where ZIRP never was a policy.
Where the mortgage industry wasn’t nationalized.
Where obama was a one term president.
How much better off we would be today.
It’s partly human nature, greed and incompetence that got us here. Under the Thatcher/Reagan regime, deregulation happened and not long afterwards, debt exploded and assetprices blew up, without wages catching up. I was watching a Steve Keen presentation recently which illustrates this perfectly. At any rate, this system is broken and I honestly cannot see anything positive for our future and the next generation’s future.
The prime rate went to 18% under Reagan and folks were practically giving away houses.
Under Bush I – 1800 bankers, mostly S&L executives, went to jail.
Still, it was a defining era and all the data clearly shows it started there. It might be water under the bridge, but to understand history is to predict the future. Meanwhile the circus continues with the elites wiping their arses on presidencies and democratic votes. (The impeachment lunacy and the Brexit farce)
2Banana, actually the prime rate hit 21% twice in one year and houses did go down in price in places, at times, but they still sold them, I know I was amazed but it happened, they used ARMs. My grandfater owned a string of hoses as rental units and he offered me one at a little over $10k, but I am telling you I did not think it worth 10k, I was just getting out of the service then and what I saw was that after years of double digit inflation when we got 1% or 2% raises (under Jimmy Carter, which is why I voted for Reagan in ’80) I could barely afford a pack of smokes no less a house. Of course I was 21 and I wish I knew then what I know now.
I also knew one of the S&L bankers that was sent to jail, the head of the local S&L and I can tell you right now, while she did do some time it was a slap on the wrist at a plush facility, mere months, and she deserved to go to jail for as long as any bank robber.
I almost forgot, Obama inherited the GFC from George Bush, much of the bailing out was done before he was even elected no less took office, once begun that bail out had to keep rolling because to stop it would have really collapsed the system, as in the entire banking system would have gone down. Many of us think that allowing it to collapse and then rebuilding a sane system from scratch would have been a long term better option, but we don’t run things and we also are not privy to the things they knew.
The Fed started injecting liquidity January 22 of 2008, on July 23, Secretary Paulson made the Sunday talk show rounds. He explained the need for a bailout of Fannie Mae and Freddie Mac.
On July 30, Congress passed the Housing and Economic Recovery Act.
September 7: Treasury Nationalizes Fannie and Freddie
September 15, 2008: Lehman Brothers Bankruptcy Triggered Global Panic
September 16, 2008: Fed Buys AIG for $85 Billion
On September 17, the attack spread. Investors withdrew a record $144.5 billion from their money market accounts. During a typical week, only about $7 billion is withdrawn.
If it had continued, businesses couldn’t get money to fund their day-to-day operations. In just a few weeks, shippers wouldn’t have had the cash to deliver food to grocery stores. We were that close to a complete collapse.
On September 20, Paulson submitted a three-page document that asked Congress to approve a $700 billion bailout.
October 3, 2008: Congress Passes $700 Billion Bailout Bill
Remember Bush is still president in 2008.
October 7, 2008 – $1.7 Trillion Commercial Loan Program and the world stock market crashes.
November we saw TARP; the auto bailout (which had to happen not because they were a large industry but because they and GE were the largest providers of funds in the commercial paper market).
And Obama is STILL not president yet.
As to the S&L disaster: Silverado Savings and Loan collapsed in 1988, costing taxpayers $1.3 billion. Neil Bush, the son of then Vice President of the United States George H. W. Bush, was on the Board of Directors of Silverado at the time. Neil Bush was accused of giving himself a loan from Silverado, but he denied all wrongdoing.[29]
The U.S. Office of Thrift Supervision investigated Silverado’s failure and determined that Neil Bush had engaged in numerous “breaches of his fiduciary duties involving multiple conflicts of interest”. Although Bush was not indicted on criminal charges, a civil action was brought against him and the other Silverado directors by the Federal Deposit Insurance Corporation; it was eventually settled out of court, with Bush paying $50,000 as part of the settlement, The Washington Post reported.[30]
As a director of a failing thrift, Bush voted to approve $100 million in what were ultimately bad loans to two of his business partners. And in voting for the loans, he failed to inform fellow board members at Silverado Savings & Loan that the loan applicants were his business partners.[31]
Neil Bush paid a $50,000 fine, paid for him by Republican supporters,[32] and was banned from banking activities for his role in taking down Silverado, which cost taxpayers $1.3 billion. An RTC suit against Bush and other Silverado officers was settled in 1991 for $26.5 million.
Can we please not practice political party Selective Memory Loss? Both the S&L collapse and the GFC had plenty of blame to go around, but they both also had two common elements, they formed during republican administrations as lax to the point of criminal regulation allowed excesses that would later be called criminal by people on both sides of the political spectrum.
“Many of us think that allowing it to collapse and then rebuilding a sane system from scratch would have been a long term better option, but we don’t run things and we also are not privy to the things they knew.”
We voted for a president that promised “hope and change” and all he did was kiss the culprits collective butts.
“Many of us think that allowing it to collapse and then rebuilding a sane system from scratch would have been a long term better option, but we don’t run things and we also are not privy to the things they knew.”
What’s there to “know”? The banking industry bet on ever increasing house prices and were wrong. Had they been forced to lose, we would have more affordable housing today and the level of outrage in the country would be much lower. Bailing out the asset holders just increased the already growing wealth gap.
No, we would be much better off today had we allowed the system to crash and rebuilt it on reasonable foundations. Instead, the elites played the “Spin Again” card.
“So, I have an observation here. Bernanke was VERY clear about how careful they were with even a single word “given” to markets. I assume that has not changed.”
What could possibly be more productive; than allocating scarce resources, not based on anything related to productive efficiency, but rather based on exactly which single word some arbitrarily privileged, confirmed halfwit happens to “give;” to what the newspeak indoctrinati, despite all evidence to the contrary, still insists on pretending has anything to do with “markets”…..
Talk about idiocy heaped on idiocy upon idiocy…. Upon idiocy… With absolutely no even remotely redeeming quality whatsoever. Literally, none! At all!
ARE you suggesting a real “free” market, that adjusts by itself..??
and NO one intervenes in prices, rates and currencies…WOW..
LETS try that,
Here in Denmark, we have negative mortage rates like 10 year – 0,50-75 % on the first 80 % of the loan, partly because the Danish kroner is NOT part of the Euro, but locked to it / until it breaks free, like the swissy, and jumps UP by 20 + %….
Most likely a MAJOR bank will sooon collapse, along with the bullion banks that can NOT repay cheap loans they used to SELL gold to buy back later, EXpect a major DIStraction soon, hidden by brexit, Greta and…..X
Hitting the ELB will not be a surprise they say.
Tacit admission all is not well (very bad) unless it’s to appease Trump for 2020.
All this probably relies on some PhD model not tested in the heat of battle whilst 5000 years of tested history is ignored.
Is it me or is someone off the deep end?
It’s me, must be
What about reflexivity?
As ELB achieved other items move and ELB moves too. It may not move back up but ski slope down.
Anyone clever enough to know what happens?
Perhaps, but doubt they have much of a voice or will be supppressed if they do have a voice and the outcome they highlight is even more dystopian.
I suppose as much as you are comfortable sleeping with – but that could be too much. So up to 1/3
This is another idea
link to investopedia.com
There are variations of the above – one needs to be comfortable wit it no matter what happens – otherwise you end up buying high and selling low – in any strategy
How big a position in gold ? What percentage of overall portfolio. What say ye?