Nomura Research Institute Conference on Risk Management for Central Banks Panel 2 Lessons from the Crisis for Central Banks a Policy View September 25, 217 Nomura Research Institute, Tokyo Richard C. Koo, Chief Economist Otemachi Financial City Grand Cube, 1-9-2 Otemachi, Chiyoda-ku, Tokyo -4, Japan r-koo@nri.co.jp
Exhibit 1. Advanced Economies in the Overlooked Other-half of Macro-Economics Borrowers (=investors) Yes No Lenders (=savers) Yes No 1 3 2 4 advanced economies are all here Textbook world (private sector maximizing profits) Overlooked other-half (private sector minimizing debt) 1. Lenders and borrowers are present in sufficient numbers (textbook world) Ordinary interest rates 2. Borrowers are present but not lenders due to the latter's bad loan problems (financial crisis, credit crunch) Loan rates much higher than policy rate 3. Lenders are present but not borrowers due to the latter's balance sheet problems and/or lack of investment opportunities (balance sheet recession, "secular" stagnation) Ultra-low interest rates 4. Borrowers and lenders both absent due to balance sheet problems for the former and bad loan problems for the latter (aftermath of a bubble burst) Ultra-low interest rates, but only for highly rated borrowers Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 1
Exhibit 2. Private Sector 1 Borrowers Disappeared 5 after 28 Average Annual Private Sector Financial Surplus(+) or Deficit(-) (% of GDP) (% of GDP) 5 years to Q3 28 from Q4 28 to present 4 latest 4 quarters 5 years to Q3 28 from Q4 28 to present 4 latest 4 quarters UK 1.63 3.38-2.97 Germany 8.46 7.4 12.13 US.48 5.21 4.12 France 2.42 2.25 -.68 Canada -.2-1.21-1.77 Italy 1.48 2.75 6.19 2 5 Japan 7.68 8.57 6.24 Spain -8.2 7.15 6.4 Korea -1.89 4.4 4.58 Greece -1.53 2.33 -.87 3 Australia -7.77.9.39 Ireland -5.41 7.28.4 Eurozone 1.65 5.1 4.62 Portugal -3.97 4.42 3.61 1. private sector = household + corporate + financial sectors 2. Entered balance sheet recession in 199 3. Entered balance sheet recession in 2 4. Until Q1 217. Only for Ireland, Q4 216. 5. Except Canada Source: Nomura Research Institute, based on these countries' flow of funds and national accounts data Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 2
Exhibit 3. Drastic Liquidity Injections Resulted in minimal Increases in Money Supply and Credit (I): US 5 45 4 35 3 25 2 15 (Aug. 28 =, seasonally adjusted) Monetary Base Money Supply (M2) Loans and Leases in Bank Credit 464 176 128 5 3. 2.5 2. 1.5 1..5 (%, yoy) Consumer Spending Deflator (core) 7/1 7/7 8/1 8/7 9/1 9/7 1/1 1/7 11/1 11/7 12/1 12/7 13/1 13/7 14/1 14/7 15/1 15/7 16/1 16/7 17/1 17/7 Note: Commercial bank loans and leases, adjustments for discontinuities made by Nomura Research Institute. Sources: Federal Reserve Board; US Department of Commerce +1.41% Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 3
Exhibit 4. Drastic Liquidity Injections Resulted in minimal Increases in Money Supply and Credit (II): Eurozone 35 325 3 275 25 225 2 175 15 125 (Aug. 28 =, seasonally adjusted) Base Money Money Supply (M3) Credit to Euro Area Residents 318 127 11 75 2.4 2. (%, yoy) CPI core 1.6 1.2 +1.2%.8.4 7/1 7/7 8/1 8/7 9/1 9/7 1/1 1/7 11/1 11/7 12/1 12/7 13/1 13/7 14/1 14/7 15/1 15/7 16/1 16/7 17/1 17/7 Note: Base money's figures are seasonally adjusted by Nomura Research Institute. Sources: European Central Bank; Eurostat Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 4
Exhibit 5. Drastic Liquidity Injections Resulted in minimal Increases in Money Supply and Credit (III): UK 7 65 6 55 5 45 4 35 3 25 2 15 5 (Aug. 28 =, seasonally adjusted) Reserve Balances + Notes & Coins Money Supply (M4) Bank Lending (M4) 1 67 136 89 6 5 4 3 2 1-1 (%, yoy) CPI (ex. Indirect Taxes) 7/1 7/7 8/1 8/7 9/1 9/7 1/1 1/7 11/1 11/7 12/1 12/7 13/1 13/7 14/1 14/7 15/1 15/7 16/1 16/7 17/1 17/7 Notes: 1. Reserve balances data are seasonally unadjusted. 2. Money supply and bank lending data exclude intermmediate financial institutions. Sources: Bank of England; Office for National Statistics, UK 2.5% Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 5
Exhibit 6. Drastic Liquidity Injections Resulted in minimal Increases in Money Supply and Credit (IV): Japan 13 12 1 9 (199 Q1 =, seasonally adjusted) Monetary Base Money Supply (M2) Bank Lending Quantitative Easing Quantitative and Qualitative Easing Earthquake 127 8 7 Bubble Burst 6 5 4 3 2 21 12 1 4 (%, yoy) 3 2 1-1 -2 CPI Core -3 85 86 87 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17.5% 2 Notes: 1. Figures for bank lending are seasonally adjusted by Nomura Research Institute. 2. Excluding the impact of consumption tax. Source: Bank of Japan Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 6
Exhibit 7. No Acceleration in Private Sector Credit or Money Supply Growth after the BOJ s QQE 34 32 3 28 26 24 22 2 18 16 14 12 8 2 1 (213 Mar. =, seasonally adjusted) Gov. Shirakawa Gov. Kuroda Monetary Base Money Supply (M2) Bank Lending (%, yoy) CPI Core (ex. fresh food) 336 117 114.5% 2-1 12/1 12/4 12/7 12/1 13/1 13/4 13/7 13/1 14/1 14/4 14/7 14/1 15/1 15/4 15/7 15/1 16/1 16/4 16/7 16/1 17/1 17/4 17/7 Notes: 1. Figures for bank lending are seasonally adjusted by Nomura Research Institute. 2. Excluding the impact of consumption tax. Sources: Bank of Japan and Ministry of Internal Affairs and Communications Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 7
Exhibit 8. Same Decoupling of Monetary Aggregates Observed in 193s 7 6 5 4 3 2 (Dec. 1929 = ) reserves with FRB deposits + currency in circulation loans NY stock market crash 1 World War II begins 489 131 52 8 6 4 2 ($ mn) banks' borrowings at Federal Reserve Banks 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 Notes: 1. deposits = demand deposits adjusted + other time deposits 2. Only this data series is based on member banks in 11 leading cities. All other data series are for all membr banks. Source: Nomura Research Institute, based on the data from Board of Governors of the Federal Reserve System (1976), Banking and Monetary Statistics 1914-1941, pp.72-75 pp.138-163 and pp.49-413 2 Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 8
Exhibit 9. QE Exit Is far more difficult than QE Entrance: QE Central Banks Must Reduce Reserves massively to Avoid Credit Explosion 35 3 (x) Bank Reserves as Multiples of Required Reserves Bank reserves statutory reserves 25 2 Japan 33.3x U.S. 12.5x Eurozone 9.5x U.K. 15.6x 15 Switzerland 3.6x 1 normal level of reserves 5 99 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 Note: The Bank of England has suspended reserve requirement in March 29. The post-march 29 figures are based on the assumption that the original reserve requirement is still applicable. Sources: Nomura Research Institute, based on BOJ, FRB, ECB, BOE and SNB data Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 9
Exhibit 1. Asset Price Bubbles Are also Prompting the Fed to Normalize Monetary Policy 24 (Dec. 2 = ) 22 2 S&P CoreLogic Case-Shiller Home Price Index: San Francisco Moody s/rca commercial real estste index (nationwide, all uses) +26.7% +11.% 18 16 14 US enacts "Pretend & Extend"* (Oct. 29) 12 8 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217 Note: "Policy Statement on Prudent Commercial Real Estate Loan Workouts" (October 3, 29) Source: Nomura Research Institute, based on the data from Real Capital Analytics; "Moody s/real CPPI," and S&P Dow Jones Indices; "S&P CoreLogic Case-Shiller Home Price Indices" Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 1
Exhibit 11. Balance Sheet Normalization Process Envisioned by Fed 5 4 3 ($bn) Estimates Normalization starts (Oct. 217?) Actual reserves = Required reserves (Jun. 221) 2 28 29 21 211 212 213 214 215 216 217 218 219 22 221 Actual reserves Currency in circulation Required reserves Note: Reserve balances, currency in circulation, and required reserves assume trends observed from January 215 to May 217 will remain in force. We assumed Fed s balance sheet reductions would begin in October 217 based on plans revealed in June 217. Source: Nomura Research Institute, based on Fed data; estimates by Nomura Research Institute Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 11
Exhibit 12. Monetary Policy Normalization Requires both Rate Hikes and Shrinkage of Monetary Base 7 (%) (1999 =) 8 6 FF Rate (left scale) Greenspan's Challenge 1 Monetary Base (right scale) 7 5 6 4 2 5 4 3 2 Yellen's Challenge 3 2 1 3 99 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 18 19 2 21 Notes: 1. Last two rate hikes were made under Bernanke. 2. Supposed to take 45 months according to schedule. 3. Supposed to take "several years" Sources: Nomura Research Institute, Board of Governors of the Federal Reserve System Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 12
Exhibit 13. Additional Private Savings Required if Fed Stops Reinvesting in USTs and MBS 14 ($bn) 12 8 6 3 12 18 6 6 24 24 36 36 3.23% of GDP 45 18 27 MBS US Treasuries may expand under Trump 4 2 US budget deficit for 216 217 218 219 22 221 222 Notes: Assumes normalization will be conducted from Oct 217 to Jun 221. US fiscal accounting year runs from October to following September. MBS = mortgage backed secirities Source: Nomura Reserch Institute (FY) Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 13
Exhibit 14. Additional Private Savings Required if ECB Begins Absorbing Excess Reserves 6 ( bn) 5 325.1 325.1 3.3% of GDP 4 227.5 3 162.5 2 16.3 217 218 219 22 221 Notes: Assumes US-style normalization will be conducted from Oct 217 to Jun 221. Fiscal deficit represents net borrowings of general government. Source: Nomura Reserch Institute based on ECB and Eurrostat data (CY) Eurozone budget deficit for 216 Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 14
Exhibit 15. Additional Private Savings Required if BOE Begins Absorbing Excess Reserves 18 (GBP bn) 16 126.5 126.5 6.52% of GDP 14 17.6 12 8 6 4 19. 31.6 2 217 218 219 22 221 Notes: Assumes US-style normalization will be conducted from Oct 217 to Jun 221. UK fiscal accounting year runs from April to following March. Fiscal deficit represents net borrowings of national government Source: Nomura Reserch Institute Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 15 (FY) UK budget deficit for 216
Exhibit 16. Additional Private Savings Required if BOJ Begins Absorbing Excess Reserves 16 ( tn) 14 12 8.4 94.6 94.6 17.63% of GDP 8 6 4 14.2 23.7 2 217 218 219 22 221 Notes: Assumes US-style normalization will be conducted from Oct 217 to Jun 221. Japan's fiscal accounting year runs from April to following March. Source: Nomura Reserch Institute, based on MOF and BOJ data (FY) Japan's budget deficit for 216 Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 16
Exhibit 17. If Not Careful, Long-term Interest Rates or Exchange Rates Could Go sharply higher when the QE Is Unwound Images of Long-term Interest Rates with and without QE (Long-term interest rate) without QE with QE Bubbl e Beginning of Economic Recovery without QE Beginning of Economic Recovery with QE t t 1 t (Time) Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 17
Exhibit 18. Required Private-sector Savings and Fiscal Deficit as Percentage of GDP Months elapsed from start of process (as percentage of 216 GDP, annualized) 1-3 4-6 7-9 1-12 13-45 Fiscal deficit US.65 1.29 1.94 2.58 3.23 3.16 Eurozone.61 1.21 1.82 2.42 3.3 1.55 Japan 3.53 7.5 1.58 14.1 17.63 7.9 UK 1.3 2.61 3.91 5.22 6.52 1.98 Note: To facilitate comparisons relative to GDP, monthly reduction in bond re-investments during each period was calculated and multiplied by 12. For the fiscal deficit to GDP ratio, the fiscal deficit for the latest accounting year was divided by 216 GDP. Source: Estimates by Nomura Research Institute, based on data from central banks, fiscal and statistical authorities, and IMF Copyright(C) Nomura Research Institute, Ltd. All rights reserved. 18