Monetary policy when interest rates are close to zero

Transcription

1 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

2 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?

3 When is it advisable to bring policy interest rates toward zero (ZIRP)? => Revitalize the economy when growth is weak Eurozone Source of data : Eurostat

4 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.

5 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.

6 Limitations of ZIRP u Importance of real interest rates: r = i - π (Irving Fisher, 1907) Source: Unctad u 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 Fixing the interest rate at a too low level leads to less flexibility for the authoriges. What is the limit?

7 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.

8 Conventional Transmission Channels Non conventional Monetary policy Focus on top of the chart Source ECB

9 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

10 Non conventional Transmission Channels Brainard/Tobin 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

11 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

12 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:

13 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

14 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

15 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

16 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.

17 Main CBs policies Long-term interest rate on gov. bonds Source: OECD StaGsGcs, November 2012

18 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

19 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

20 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?

21 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

22 Difference between Quantitative and Credit Easing Source: Lenza, M., H. Pill, and L. Reichlin (2010), Monetary Policy in ExcepGonal Times, Economic Policy, April 2010

23 Main CBs policies CBs objectives Source: Loisel Olivier, Stratégies de poligques monétaire, June 2006

24 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

25 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

26 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

27 Should ZIRP be exited? When? Growth recovery Debt reducgon PosiGve and stable inflagon How? o Strong non- convengonal measures o Policy- mix to sgmulate the demand (Ex: massive purchases of bonds by the bank of England; Ex: expansionary fiscal policy)

28 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?