What Else Can Central Banks Do ? Marking the launch of the - PowerPoint PPT Presentation

“What Else Can Central Banks Do ?” Marking the launch of the Eighteenth Geneva Report on the World Economy Presented by Patrick Honohan (Trinity College Dublin and CEPR) Discussants Sir Charlie Bean (LSE and CEPR) Thursday, 15 September 2016 1 Gene Frieda (Pimco)

Frequency and Cost of ZLB Real interest rate r = i - π e Lower neutral real rates and lower inflation since 1980s means that the liquidity trap has become a widespread reality. Can become more frequent (if lower future neutral real rates). Thursday, 15 September 2016 2

Cost of ZLB If neutral real interest rate is 1% and inflation target 2%, then Taylor rule will generate optimal nominal policy rate at or below zero often: whenever unemployment exceeds NAIRU by as little as 1.1% Figure shows interest, unemployment and inflation in the US 2008-15 historical and counterfactual if policy rate could have reached the Taylor level of minus 6% Thursday, 15 September 2016 3

Policy Implications Step-by-step Others should help: but what can central banks do to meet their mandate? Unconventional monetary policy necessary in future Negative interest rates (NIR) Quantitative easing (QE) Helicopter money Influencing inflation expectations Policies to reduce the incidence of the liquidity trap Raising the inflation target Periodic re-examination of inflation targets The long view: Monetary policy in post-cash economies Thursday, 15 September 2016 4

Negative Interest Rates (NIR) Recent experiences in five countries suggest that: • NIR transmits largely as expected (anomalies in banking) • Rates can be cut even further into negative, if temporary • Concerns about side effects but tend to be overstated Thursday, 15 September 2016 5

Quantitative Easing (QE) Literature unambiguously shows QE lowers bond yields. Adverse side effects but tend to be overstated. Notably, fiscal implications are benign. Previous QE had stimulus equivalent to cut in short rate of 3%... ... and there is scope for more in many countries. Assets other than government bonds can be brought into the mix. Thursday, 15 September 2016 6

Quantitative Easing (QE) Asset stock leaves large scope for QE in major countries. % GDP, end 2015 Thursday, 15 September 2016 7

QE vs ‘Helicopter Money’ QE works through costs of finance; helicopter money policies channel liquid purchasing power to agents more likely to spend it. Has strong fiscal component – beyond mandate of most CBs Coordinated fiscal-monetary nature make it powerful Needs careful governance to ensure central bank independence and prevent risk of fiscal dominance Ideally: independent measures by fiscal and monetary authorities, each taking account of what other is doing Thursday, 15 September 2016 8

Forward Guidance on Inflation A credible promise of higher future inflation can reduce current real interest rates. Forward guidance has worked, within limits. A higher inflation target can be a powerful commitment device for raising inflation expectations. Forceful communication and credible supporting policies are needed to convince markets. Thursday, 15 September 2016 9

Monetary Stimulus and Financial Stability Risk of exuberance similar for conventional and unconventional monetary easing Search for yield, excess leverage Macropru tools are best for financial stability, but questions as to effectiveness Monetary policy blunt instrument against financial instability ZLB more likely to occur in conditions of low exuberance. Thursday, 15 September 2016 10

Raising the Inflation Target Limits to QE, NIR and forward guidance are suggestive of benefits to preempting the liquidity trap. Low targets reduce normal nominal interest rates, increase the ZLB incidence and target undershooting. Low targets may have become inconsistent with central banks' macro stability mandates. Inconsistency is likely to persist or worsen, unless neutral real interest rate reverses downward trend. Thursday, 15 September 2016 11

Target Credibility The most credible target is the one most consistent with the mandate. Link inflation target to the mandate. Analysis should factor in risks and costs of liquidity trap. Targets should not be fixed forever. Cost and benefits change over time and across countries. For example, the neutral real interest rate may change. Periodic re-examination of inflation targets ensures continued consistency with mandates. Thursday, 15 September 2016 12

The Post-cash Economy The liquidity trap is created by the availability of cash. Cash is needed as a means of payment. New payments technologies reduce the need for cash. If cash can be phased out, liquidity traps will be obsolete, and optimal inflation targets will likely be lower. Diminished use of cash raises issues of social inclusion, privacy of payments and digital security. Thursday, 15 September 2016 13

The Post-cash Economy Some countries' payments systems are quickly becoming cashless. Thursday, 15 September 2016 14

Conclusions 1. Central banks have firepower in a liquidity trap • Reduce policy rates below zero • Expand scale and scope of QE • Commit to higher future inflation if credible 2. Raise inflation targets and introduce recurrent reviews • Low targets may be inconsistent with CB mandates 3. Long view: LB obsolete in Post-cash economies Thursday, 15 September 2016 15

16 Annex: Abenomics Thursday, 15 September 2016

“What Else Can Central Banks Do?” Discussion of Geneva Report 18 Charles Bean (London School of Economics & Office for Budget Responsibility) ING, 15 September 2016 Thursday, 15 September 2016 17

Context • Natural real interest rate↓ “World” 10 -year risk-free real interest rate  Savings “glut” (demographics, inequality ↑, crisis)  Investment “strike” (TFP growth ↓, demographics, crisis)  Portfolio shifts (EME reserves ↑, crisis, re-regulation)  Low natural rate likely to persist • GFC also showed that shocks can be bigger and more persistent than we thought • ZLB no longer a curiosum, but a material issue for CBs Thursday, 15 September 2016 18

What can CBs do in this environment? • Negative policy rates • Asset purchases • “Helicopter” money • Forward guidance and price-level/nominal GDP targets • Raise the inflation target? Thursday, 15 September 2016 19

Is Zero really a Lower Bound? • Technical LB negative because of carrying costs of cash  TLB is probably around -1%  But squeeze on bank profits inhibits credit supply → effectiveness of rate cuts↓ → effective LB may be higher and is state-contingent  May be able to offset with tiered rates or CB lending programme • More exotic options?  Charge interest on cash (Gesell)  Eliminate cash altogether (Rogoff);  Break link between cash and reserves (Eisler)  These strike at money as a store of value and likely to be unpopular! (NB: declining importance of cash as a means of payment is irrelevant – need to impair/outlaw its role as a store of value) Thursday, 15 September 2016 20

Asset purchases (QE) • Event studies suggest QE1 reduced US & UK yields by ≈ 1pp • But…:  May be less effective with normally functioning markets  Significant distributional consequences  Purchases of public debt takes CB into political territory  Purchase of private assets takes CB into political territory  Effect on exchange rates/capital flows creates international tension  Heightened financial stability risks (encourages search for yield, etc) • Asset purchases take CB into political territory – need to have consent of Treasury/MoF • Risk-return trade-off deteriorates as QE is used more intensively Thursday, 15 September 2016 21

“Helicopter” money • Helicopter money ≡ temporary income tax cut + permanent QE • Fiscal part  Propensity to spend out of a temporary rise in income is small → need a very big injection to have a material effect on demand today  Makes more sense to finance public investment, not an income tax cut • Monetary part  Reserves pay policy rate → only affects public sector budget constraint via term premia (if part of reserves pay less, then effectively a bank tax)  Can’t commit not to withdraw the reserves in the future; doesn’t make sense to talk about part of stock of high-powered money!  CBs will unwind QE only as needed to meet their mandates – have they been like Monsieur Jourdain and “speaking prose” all along? Thursday, 15 September 2016 22

Forward Guidance • Woodford: Keep policy rate “lower for longer”  Lowers long real rate by depressing future nominal short rate and raising future inflation (“commit to be irresponsible”)  Policy is time inconsistent; policy makers can’t commit their successors so such “irresponsibility” is incredible • Price- level/nominal GDP target aims to get round this by “hard - wiring” the required history dependence in policy  But this just re-locates the problem to whoever sets the target  Actual guidance surely more about communication (“Delphic”) than implementing a time- inconsistent policy (“ Odyssean ”) Thursday, 15 September 2016 23