slides - Paris School of Economics

Monetary policy when interest
rates are close to zero
University Paris 1 Panthéon-Sorbonne
Economic Policy – FS 2012
Wafy Boubaker, Davide Castelli and Thomas Pernet
Framework
1.When is it advisable to bring policy interest rates toward zero (ZIRP)? The risk of such policy: the liquidity trap LimitaGons 2.ConvenGonal transmission channels Non convenGonal monetary policy (NCMP) Non convenGonal transmission channels EffecGveness of the NCMP? Two econometric models 3.AlternaGves Policies at ZBL. Difference between QuanGtaGve and Credit Easing Main CB's policies 4.When and how should ZIRP be exited? When is it advisable to bring policy
interest rates toward zero (ZIRP)?
=> Revitalize the economy when growth is weak
Eurozone 1996-2012
Source of data : Eurostat
When is it advisable to bring policy
interest rates toward zero ?
=> Revitalize the economy when growth is weak
IS-LM Model
=> In case of debt crisis: deleveraging At a very low interest rate, banks know that prices will decrease. Hence, debtors sell their assets to give the money back. Risk of ZIRP
Liquidity trap
The keynesian approach
x
IS : Y = cY + bi + G + X(e) - M(e)
LM : M = lY + l'i
l'
+ oo : the speculation demand is totally elastic.
At the critical interest rate x, the created money is
hoarded.
The monetary multiplicator tend to zero.
Why: markets expect the price of assets to fall.
Limitations of ZIRP
u 
Importance of real interest rates: r = i - π (Irving Fisher, 1907)
Source: Unctad
On the one hand, a rise in inflaGon can lead to the ruin of investors who have bought securiGes. On the other hand, a sharp fall in inflaGon would cause high real interest rates (with a nominal -­‐ -­‐ interest rate difficult to reduce) => deflaGonary spiral u  A possible capital flight is possible : loss of deposits and financial destabilisaGon, risk of a sharp depreciaGon of exchange rates, inflaGon BP: X(e) -­‐ M(Y,e) + K(i) = (R) = 0; X'e<0, M'y>0, M'e>0, K'i>0 (Mundell-­‐Fleming) u 
u 
Fixing the interest rate at a too low level leads to less flexibility for the authoriGes. What is the limit ? 1
2
3
Source : Eurostat
Statistics between 2000 and 2006)
Japan case and liquidity trap: In spite of zero interest rates, the graphs 1 and 2 don't show a relevant relaGonship between the nominal interest rates and the GDP growth. The graph 3 describes a deflaGonary spiral. Conventional Transmission
Channels
Non conventional Monetary policy Focus on top of the chart
Source ECB
Non Conventional Monetary Policies
Three main reasons: 1. Monetary Policy transmission channel can be defected -­‐QuanGty constraint -­‐Transmission channel too slow, less important -­‐Not enough compare with macroeconomic requirement 2. Cut in director interest rate has already done before -­‐IntervenGon possibility -­‐technically impossible 3. Manage choc liquidity
Key S&mulus : Back to Higher Infla&on expecta&on Source ECB
Non conventional Transmission
Channels
Brainard/Tobin 1968 1. Money is an imperfect subsGtute OMO Increase/decrease money base = Impact on non monetary assets. Bond yield and Stock yield are not equal Spread between EURIBOR And EONIA leads to liquidity problem reduce spread is a task : premium and/or Risk premium:
-­‐ The central bank can commit to keeping the overnight rate at or near zero -­‐ Impact riskless and risky assets : Private borrowing, lending and spending decision depend on risky assets, reducing their spread over riskless assets reduce the interest rate. Source ECB
Non conventional Transmission
Channels
2. Budget Channel :
Helicopter drop Friedman 1969
"Let us suppose now that one day a helicopter flies over
this community and drops an additional $1000 in bills from
the sky,... Let us suppose further that everyone is convinced
that this is a unique event which will never be repeated" Friedman
- CB swaps direct taxes to a tax seigniorage
CB -­‐-­‐-­‐-­‐-­‐-­‐> Lends directly to Economic agent : Spending excess cash holding Source FED
Source ECB
Non conventional Transmission
Channels
3. The Signal
BC pledges explicitly to maintain for a while its interest rate at a low rate or even at lower bound rate.
Apply "rules rather than discretion" principle.
Kydland and Prescott 1977
Outright monetary Transaction
Draghi Signal 6 september.
Transactions will be focused on the shorter part of the
yield curve, and in particular on sovereign bonds
with a maturity of between one and three years
source: http://cib.natixis.com/flushdoc.aspx?id=65720
Effectiveness of the NCMP
1) Visibility Friedman 1968: DeflaGonist implosion. influence real long-­‐term interest rates by impacGng on market expectaGons r=R-­‐E(πt+1) r= real interest rate R= nominal rate E(πt+1) = ExpectaGon inflaGon R is constant (nominal interest rate lower bound + Central Bank commitment) Long term rate= average short term ExpectaGon: E(Rt+1,n-­‐1). -­‐CB Commitment to stay at a lower bond for a while, it is credible and accepted by all. => expectaGon channel tends to flaqen yield curve => prevent inflaGon expectaGon from falling(otherwise r up, limit spending) => E(πt+1) increases so r decrease => Improves borrowing and spurs aggregate demand Average short term expectation
Source : Macroeconomic Course M1
Structural model and econometric
estimation
First application : Effect on non conventional monetary policy announcement on LIBOR-­‐OIS spread. Result of this regression -­‐All PosiGve variables increase the spread. -­‐All NegaGve variables decrease the spread. Source: Urszula Szczerbowicz Paris 1
Structural model and econometric
estimation
Second application : Effect on non conventional monetary policy announcement on long term interest rate. Results of this regression : -­‐ Liquidity faciliGes decrease expectaGon of interest rate from 1 month to 1 year. -­‐ Not real conclusion about lowering the expectaGons of interest rates from 1 mouths to 1 year. Source: Urszula Szczerbowicz Paris 1
Effectiveness of the NCMP
Moral Hazard
Bank can be discouraged to implement transacGon on the money market and so refuse to restructure Its management Exit Strategy
how and when do central banks need to unwind the extra monetary sGmulus? When : As soon as the economy rebounds and inflaGonary prospects are back How: Take liquidity back from the money market, increase reserve yields. Main CBs’ policies
Long-term interest rate on gov. bonds
Source: OECD StaGsGcs, November 2012 Alternatives Policies at ZBL
3 class of policies: 1. 
CommunicaGons policies 2. 
Increasing in Central Bank’s balance sheet (quanGtaGve easing) 3. 
Altering Central Bank’s balance sheet composiGon 1. Communication Policies
• 
Private sector’s response to the short-­‐term and long-­‐term interest rate • 
Importance of expectaGons • 
How influence private-­‐sector expectaGons: •  Transparency •  Rules •  CondiGonal vs. UncondiGonal policies • 
Scholars’ empirical evidences 2. Increasing in Central Bank’s
Balance Sheet (Quantitative Easing)
• 
“Normal” easing, bring the interest-­‐rate down to zero • 
QuanGtaGve easing, far away from the necessary level (e.g. Japan 2001) • 
DeflaGonary objecGve • 
No effect if fricGonless financial market • 
Why quanGtaGve easing? 3. Altering Central Bank’s balance sheet composition
• 
Composition of BCs’ balance sheets as potential lever
• 
Influencing the supplies of different securities
• 
Changing in the BC’s assets
• 
Objective: lower long-term interest rates
Difference between
Quantitative and Credit Easing
Source: Lenza, M., H. Pill, and L. Reichlin (2010), “Monetary Policy in ExcepGonal Times”, Economic Policy, April 2010 Main CBs’ policies
CBs’ objectives
Source: Loisel Olivier, “Stratégies de poliGques monétaire”, June 2006 Main CBs’ policies
Short-term interest rate
Source: OECD StaGsGcs, November 2012 N.B. : Denmark sets negative nominal interest rates for the first time (2012): savings taxation
Main CBs’ policies
CBs’ alternatives policies (focus on ECB)
Source: Constâncio, V. (2011), “The ECB's experience with unconvenGonal measures”, PresentaGon at the US Monetary Policy Forum,” New York, February 2010 Main CBs’ policies
CBs’ alternatives policies (focus on ECB)
Source: Blinder A. S.. (2010)), "QuanGtaGve Easing: Entrance and Exit Strategies", Paper, Federal Reserve Bank of St. Louis, November 2010 Should ZIRP be exited ?
When ? • 
• 
• 
Growth recovery Debt reducGon PosiGve and stable inflaGon How ? o 
o 
Strong non-­‐convenGonal measures Policy-­‐mix to sGmulate the demand (Ex: massive purchases of bonds by the bank of England; Ex: expansionary fiscal policy) Conclusion
• 
• 
Monetary policy macroeconomic 's models seem to be reliable. Econometric regressions proof not compelling results. New quesGons have been liyed up. -­‐ What about big balance sheet's size ? -­‐ No payback junk assets. -­‐ Finally, how to manage temporal incoherence?