The media's blind spot: Negative IOR
By Scott Sumner
The media has an agenda, which covers its reporting of negative interest on reserves (IOR). Let’s review the evidence:
In late January, the Bank of Japan cuts interest rates into negative territory and does a bit more QE. The yen plunges in value and the Nikkei soars higher. So negative IOR seems expansionary.
Here’s what happened next, according to commenter Mikio from Japan:
The market fell as soon as the BOJ began making clear that the rate will be charged on a very small proportion of the excess reserves.
The story background is the same. There is a lot resistance in Japan against negative rates – and BOJ official soon after the decision started to “appease” critics of negative rates that “it’s not that bad, we are not really going to charge you interest, don’t worry, very little will change”.
Markets began to rally again only after BOJ Deputy Governor Hiroshi Nakaso on 12th Feb. in NY made clear that there is still “no limit” to QE and that BOJ can cut rates further into negative territory, and that those who think the BOJ has reached its limit are “wrong”.
1) Nikkei rose when the initial announcement was made
2) Fell when BOJ started blurring the message
3) Rose again when BOJ corrected the message
It’s funny how many people find it so difficult to see these things. That’s what’s “head-scratching”…
This all seems pretty clear to me, but just in case Mikio and I are wrong, let’s see how the European markets react to negative IOR.
European stocks soar and the euro falls on a 12:45 pm announcement by the ECB that the policy rate will be cut deeper into negative territory. Then at 1:56 Draghi seems to abandon his “whatever it takes” approach, and indicated that no further rate cuts were likely. The euro soars in value and stocks plunge. Then overnight, ECB officials rush to reassure investors that they are serious about monetary stimulus, and stocks soar the next day. Exact same story as in Japan.
But let’s say that even that is wrong. Early today the BOJ gives us another experiment, this time refusing to cut rates. The yen rises and Japanese stocks fall sharply. Zero Hedge suggested that the lack of rates cuts today was not a big surprise, but this was:
BOJ REMOVES LANGUAGE FROM ITS STATEMENT THAT IT WILL CUT INTEREST RATES FURTHER INTO NEGATIVE TERRITORY IF JUDGED
So all of these market moves suggest that negative IOR is clearly expansionary, just as economic theory would predict. But bankers don’t like negative IOR. So even as the markets are telling us (indeed screaming at us) that negative IOR is expansionary, the business press tells us the opposite, even though all of the natural experiments discussed above were accurately reported in the FT.
Today’s FT is an especially egregious example. Here’s the headline:
Equities slip as BoJ holds steady
When I see the headline I think to myself “Finally, the FT will get it right!”
The story starts off in a promising direction:
The yen is firmer, and stocks and commodity prices softer, after the Bank of Japan downgraded its view of the world’s third-biggest economy but made no change to monetary policy.
Then things start to go awry:
The central bank’s surprise move to push interest rates into negative territory on January 29 has had the opposite effect to what was desired for the yen.
What! Didn’t the yen plunge much lower on the January 29th announcement? Has the FT not heard of the Efficient Markets Hypothesis? The markets don’t react with a one-week lag to policy announcements. And didn’t today’s reaction to the lack of a rate cut further confirm that negative IOR is expansionary?
Then things start to get back on track:
European Central Bank president Mario Draghi, who last week cut interest rates to minus 0.4 per cent, boosted the size of its asset purchase programme and offered incentives to banks to increase lending, also said he was reluctant to push rates even lower because of the detrimental impact it could have on banks.
Such fretting has boosted the “haven” yen, leaving it up more than 6 per cent for the year versus the US dollar.
OK, that’s good; the term ‘fretting’ clearly refers to Draghi’s suggestion that no more rate cuts are coming, and similar statements out of Japan.
But then everything falls apart:
Binky Chadha, a strategist at Deutsche Bank, highlighted the view that recent actions by central banks, namely the BoJ and ECB, have generated large and opposite reactions than might have been intended, particularly when compared with the relative success of the Federal Reserve’s quantitative easing programme, which weighed on the dollar.
“The empirical record indicates multiple episodes of central bank easing actions that resulted in large and opposite reactions to those intended. Those that succeeded either coincided with positive fundamental developments or were part of a package that led to expectations of such,” he said.
I’m sort of in a state of shock. Time after time after time the markets clearly signal that negative IOR is expansionary. Even the press can hardly fail to report the immediate market reaction to negative IOR. And yet they are somehow unable to actually report what is starring them in the face, and instead find Binky Chadha, who tells them that up is down and black is white.
PS. I don’t know why Chadha is unable to see the obvious, but someone more cynical than me might note who employs him. If Upton Sinclair were alive today, he might have this to say:
It is difficult to get a man to understand something, when his salary depends on his not understanding it.
PPS. BTW, people often get confused by these posts. I’m not a big fan of negative IOR, or indeed any form of interest rate targeting. I prefer NGDPLT, or if not that then price level targeting, or if not that then QE. Negative IOR is way down my list.
HT: JP Koning