Suppose I announced I would be buying an asset, both now and in future. And suppose people believed my announcement. It would be paradoxical if my announcement caused the price of that asset to fall. It would be even more paradoxical if I had said I was buying the asset because I was trying to make its price go up. That's what's been happening in Japan. Bond prices have been falling (and so bond yields have been rising), as a result (probably) of Abenomics.
There are a few cases where this paradoxical result might happen:
Maybe I have a reputation for being a really bad investor, who always loses money. So when other people see me buying houses, they all decide to sell their houses.
Maybe the sheer knowledge that I own an asset makes that asset less valuable. Because I'm so very unfashionable that if I buy a Burberry swimsuit everybody else stops buying Burberry.
Or maybe I'm buying taxi medallions, and paying for them with newly-produced bicycles. With a flood of bicycles on the market, fewer people want to take a taxi, so the medallions are worth less.
That last example is the closest to the current Japanese case. It's not just what you buy, but what you buy it with. An increase in the stock of bicycles in circulation on the streets, both now and in future, will have an effect on the demand for taxi medallions. An increase in the stock of money in circulation, both now and in future, will have an effect on the demand for bonds. Because it can raise the expected future price level, and/or expected future real income, which would reduce the demand for bonds.
If you think of monetary policy as interest rate policy, it's hard to escape the paradox. It's like if your mechanic hooks up your car's power steering hoses the wrong way around. So if you try to turn the steering wheel clockwise, to turn the car right, you are surprised to feel the steering wheel fight back, actually turn counterclockwise, and the car turn left. Once you figured out how it worked, and got used to it, you might be able to steer the car. But is the English language up to the job of clearly describing what you are doing when you steer the car? "Which way are you trying to turn the steering wheel??". My guess is that the Japanese language would have the same problem.
If you are aware that printing money and buying bonds and "trying" to force bond yields down will in fact result in economic recovery, and expectations of recovery will cause a rise in investment, a fall in saving, and less demand for the liquidity and safety of government bonds, and these will cause a rise in bond yields, and if you intend that economic recovery to happen, and you are willing to accept that rise in bond yields as a side-effect of that recovery, are you really truly trying to force bond yields down? Well, yes and no. But the rise in bond yields does not mean your policy has failed. On the contrary, it means your policy is succeeding.
Is the Bank of Japan trying to push down bond yields? Well, yes and no. Yes, it is fighting a battle to push down bond yields, but that battle is part of a wider war for economic recovery. And if it wins that war for economic recovery, it will lose that battle to push down bond yields. So it wants to lose that battle to push down bond yields.
This is what Ambrose Evans-Pritchard says that Richard Koo says:
"As I reported last night, Mr Koo thinks the Abenomics plan of monetary
reflation is madness. “Once inflation concerns start to emerge the BoJ
will be unable to restrain a rise in yields no matter how many bonds it
buys.” This could lead a “loss of faith in the Japanese government” and
the “beginning of the end” for Japan’s economy."
Yep. When the Japanese economy recovers enough from deflation and recession, the BoJ will be unable to restrain a rise in bond yields. Because the harder it "tries" to restrain them, the more the equilibrium yield will rise. But when the recovery looks strong enough, the BoJ will stop "trying" to restrain bond yields, and start "trying" to increase them, at which point those bond yields will stop rising.
Ambrose also says that Richard Koo is "... Japan’s most famous economist and an arch-Keynesian." There's a lot of weight placed on the "arch" bit in "arch-Keynesian. Paul Krugman is a Keynesian, but I don't think Paul would have a problem recognising that Abenomics, if successful, would drive up bond yields. I think he would cheer the rise in bond yields, and say it means that the BoJ has escaped the liquidity trap, so that monetary policy once again has "traction". Is Richard Koo really a Keynesian? Or is he just a finance guy, who doesn't really get macro/money? (I don't know the answer to that question.)
This is not the "beginning of the end" of the Japanese economy. But it might be, and I hope it is, the beginning of the end of Japan's long recession.
And if this is indeed the beginning of the end of Japan's long recession, it will also be the beginning of the end of Richard Koo's thesis that monetary policy is powerless in a balance sheet recession, and that only fiscal policy can offset private sector deleveraging. And we can only regret that Japan did not do this many years earlier, instead of wasting all those years and letting Japan's government debt/GDP ratio climb. Because that high debt/GDP ratio is the only reason why someone might want Japan's economic recovery but not want the higher interest rates that will accompany that recovery. Which is no reason to try to stop the recovery. Though it is one additional reason to regret not having done something like Abenomics a lot earlier.
Worthwhile Canadian Initiative 
“But I’m wondering what is your reason for believing that?”
The states of the world with higher inflation in Japan are likely better than the states of the world with low inflation in Japan. Thus, investors will want to hedge low inflation states relative to high inflation states, so the inflation risk premium is negative. In normal times, in well functioning economies, the opposite argument holds.
“then your expected average of short rates over the next 10 years is zero.”
The short rate can be 0 and inflation can be 2%, because the real short rate is negative. How can they be in a liquidity trap, if they can raise expected inflation.
“if Japan could really control inflation with the current policies, it would set a level of inflation sufficiently high so that regardless of how negative the real rate was”
How can you live in the world of the last 5 years and not believe suboptimal monetary policy exists or at least that it could exist in theory? Moving to a 2% target was radical as is. The Yen has depreciated 25% since November. What if the BOJ traded 150 yen for every dollar, still think they couldn’t create inflation? Why don’t they just buy up all of Japan’s outstanding debt? Then the BOJ could forgive it, and Japan would never have to pay it back. They could buy other assets and just fund their government off the interest payments. No need for taxes. If Japan was really in a liquidity trap, wouldn’t they jump on this free lunch?
Charlie,
Lots of confusions between monetary and fiscal policy in your last post. Hint, “forgiving” debt, or purchasing risky debt is not monetary policy, and the BoJ cannot do it anymore than it can do helicopter drops. The Fed can’t do this, either.
But these types of category errors are to be expected from those who believe that monetary policy is the key to managing aggregate demand (it never was) in a ZLB context. They immediately switch to advocating fiscal policy (e.g. giving money away or debt forgiveness), but call it monetary policy.
Absolutely with sufficient fiscal policy, Japan escapes the liquidity trap, and lack of sufficient fiscal policy is the main reason why Japan has remained in this trap. Debt forgiveness, wealth transfers, more social insurance, giving people money — yes, all of that is needed, and none has anything whatsoever to do with monetary policy or what any central bank is allowed to do.
rsj: since the government of Japan owns the Bank of Japan, and (sooner or later) gets all the BoJ’s seigniorage profits, the link between monetary policy and fiscal policy is impossible to escape. If the BoJ bought all of the government debt, and held it permanently, it would be exactly as if the BoJ then “forgave” that debt. Because all the BoJ is saying is that it makes no sense for the government to hand over billions of yen to the BoJ every year for interest on debt that the BoJ then hands straight back to the government.
Nick, you need to be a bit more precise when you say “link”. The issue is one of authority and responsibility. Yes, the Japanese treasury owns the BoJ and collects all bank profits and pays for all bank losses. Therefore central bank actions have fiscal consequences for the Japanese government — there is a link. Because of this link, governments keep their central banks on a short leash and do not authorize them to bear a lot of risk. Any asset purchased by a central bank is effectively guaranteed by the treasury, so the set of assets that Treasuries allow central banks to buy is (primarily) limited to assets already guaranteed by the treasury. The link explains why central banks are kept on a short leash so that fiscal policy remains the purview of elected officials rather than bank appointees — because the elected officials prefer to keep this power to themselves and they are the ones calling the shots vis-a-vis what the central bank can do.
A notable exception would be the EU, where the ECB is trying to call the shots, telling legislatures what fiscal measures they can and cannot take. We see from this how grotesque such an inversion of control is, which should explain why other nations do not have such arrangements.
But if the larger point is that fiscal measures are the key to re-igniting healthy levels of inflation, and out of ideological purity, you will only agree to undertake such measures if you call them “monetary” — e.g. redistribution of wealth, income guarantees, etc — then what the hell, call the measures monetary policy if you want, as long as the measures are undertaken. But no, forcing banks to hold a few more reserves isnt going to do anything for inflation, because goods and services are still too expensive in Japan for the middle class to increase consumption spending on them. Japan is a very expensive country, with median wage shares of GDP falling more rapidly in Japan than in any other OECD nation. As long as these wage repression policies remain in place, you are not going to ignite inflation regardless of how many excess reserves the BoJ is forcing on the financial sector.
A good comparison nation here would be S. Korea, which is also an export oriented nation, is also resource constrained, and yet unlike Japan has a rich history of union actions, strikes, and rapidly rising wage shares. Korea, paradoxically, is not stuck in a ZLB environment and faces positive levels of inflation. The difference between Korea and Japan is really striking.
rsj: the “link” I’m talking about here is simply accounting. The central bank’s monetary policy affects the central bank’s profits, and those profits are (sooner or later) given to the government, and the government (sooner or later) spends those profits (by increasing G and/or cutting T), which is fiscal policy.
Nick, yes, but I’m making the point that because CB P & L shows up on Treasury’s balance sheet, none of the policies mentioned by Charlie or, in other cases, yourself (such as helicopter drops or private equity purchases), can be undertaken by Central Banks because of their fiscal consequences.
But too often, I get the sense that monetarists believe everything to do with “money” is controlled by the central bank, while everyone else is exchanging CPI baskets.
That isn’t the case in a monetary exchange economy.
IMO a more correct dividing line is that nominal income flows are affected more by fiscal policy whereas interest rates are affected more by monetary policy. Yes, there are links between these, but to the degree that there is overlap, it is the fiscal authority that needs to authorize/allow the monetary authority, and the monetary authority limits the overlap as much as possible in deference to the fiscal authority. ECB is the reverse.
rsj: then since all CB actions will affect their profits and losses, which will show up on Treasury’s balance sheet, you are saying that no CB actions can ever be undertaken.
No, I didn’t say that. I said it was about authority and responsibility. The government has given the CB responsibility for interest rate management and this effects seignorage income, but CB can do it. But paying interest on reserves, for example, required an additional act of congress because this would affect seignorage income as well. It remains the case that CBs cannot take losses, they have to buy primarily guaranteed debt. That is a big difference between some of the conversations here, where CBs can do whatever they want as long as it somehow involved money (e.g. charge negative interest rates, purchase shares of private businesses, etc.)
Nick is of course right.
How about this then: the BOJ buys all of the outstading Japanese debt, then all of the outstanding US debt, then all of the outstanding Euro debt. Each year it will receive a tremendous amount of interest payments, which it will remit to the Japanese gov’t. Everything still works and no laws are broken!
Also, you made quite a few statements that are just factually wrong, for instance, ” so the set of assets that Treasuries allow central banks to buy is (primarily) limited to assets alreadyguaranteed by the treasury. ”
The BOJ holds commercial paper, stock and real estate etfs, corporate bonds as well as gold and FX. They can certainly buy more as well. All of this info is publicly available.
http://www.boj.or.jp/en/statistics/boj/other/acmai/release/2013/ac130531.htm/
How come WCI always gets more comments than my blog? WAAAAAHHH.
In a standard New Keynesian model, the interest rate would not rise immediately as a result of expansionary monetary policy.
Noah:
1. Last time I checked, your blog posts seemed to be getting lots of comments!
2. I’m trying to work out whether you are right on that, in all cases:
Suppose the central bank announced an increase in the inflation target. That would certainly increase future nominal interest rates in a standard NK model. Even if the 1-period nominal interest rate fell, the current multi-period nominal interest rate would rise (if there are enough periods). We are talking 10 years bonds here.
Suppose we modified the standard simple NK model, so that there was a lag between the loosening of monetary policy and the increase in real output. (It takes time for firms to implement new investment projects.) The increase in expected future real income, relative to current real income, would increase the current equilibrium real interest rate. You can think of this as the loosening of monetary policy causing the IS curve to shift right, as well as causing a movement down along the IS curve. Though I prefer to think of it as an IS curve that slopes up, so that the real effects of a loosening of monetary policy causes an increase in the real interest rate at which desired S = desired I.
I’m pretty sure that rates are lower with the monetary expansion than without…I think that just follows from everything being concave…
Also, see this: http://noahpinionblog.blogspot.com/2013/06/the-zero-upper-bound.html
Noah: It’s pretty easy to get nominal rates being higher with the monetary expansion. Just assume, quite reasonably, that monetary expansion implies higher expected inflation. And if monetary expansion leads to higher expected growth of real income, you could get higher real rates too.
I always get concave and convex muddled. Plus it’s late here, and my brain is tired. But I think I see where you are coming from there. But here’s another way of thinking about it: assume people expect the economy to be in recession next period. Now the BoJ announces this period that it will loosen monetary policy next period, and people think this will cause the economy to recover next period, and so they now expect both a higher price level and higher real income next period. here’s my old post on upward-sloping IS curves
I had a quick skim of your post. Will give it a more careful read, and try to respond.
JP is an open economy. Long term interest rates are determined through the uncovered interest parity condition (corrected for the liquidity trap). So suppose that something (fear that political pressure form abroad – or monetary intervention/easing abroad) is temporarily blocking half way the yen depreciation. Then nominal long term interest rates will rise above what you suggest (the level apt to accomodate an improved outlook for growth), and most likely real interest rates will rise too, and too much.
JP would be better off by announcing that the short term $/Yen exrate target is 120 (so as to reach it overnight) and that from there on they expect a very very slow appreciation. This announcement would cause a Yen collapse (to 120), but long term interest rates will stay low ‘forever’.
Regards.
PierGiorgio: OK. If monetary loosening causes an expectation of ongoing real exchange rate depreciation, that would tend to force up Japan’s real iterest rates. But my sense is that the real exchange rate has already depreciated, and from now on there will be expected appreciating. So the effect would go the other way. Trying to remember how overshooting models apply in this case….
But more generally, yes, the BoJ/Abenomics communications policy leaves much to be desired, in telling people they were trying to push interest rates down. It would have been better, IMO, if they had instead said they were trying to increase future NGDP.
Nick, you have a – well – knack for great analogies. The bicycle really should help the confused understand Abenomics. I have a response to DeLong in which you might be interested (I think we’re striking the same point from a different angle). I discuss this in full here – http://bit.ly/165liic – but this is a concise comment I left for DeLong:
“1. No reason to believe that the wedge between public-private yields wouldn’t happen where both fall (in real), just private more than public. But even if you are correct, lower private cost of capital implies higher wages and capital income, and definitely higher profits. This makes debt more sustainable through tax revenues. The effect of each may not cancel out, but it can’t be perceived so simply.
2. Money non-neutrality in the medium-run doesn’t require necessarily Keynesian assumptions, just the relaxation on an exogenously-set time preference. Endogenizing this adds a whole lot of problems, but there are descriptive and agent models that support non-neutrality where time preference is a positive function on real financial wealth. The models which maintain neutrality with an endogenized time preference make really weird assumptions. Becker and Mulligan (1997) show ways in which this can be endogenized.
3. If we’re talking about “unsustainable debts” – and we are – more “risk tolerance” can also imply an increased demand for Japanese public debt, since the premise itself is “risky”, it seems like a self defeating question. Or maybe my point is circular here?
4. Japan should move to a 4% rather than 2% interest rate. Mundell-Tobin talks within the context of a one-time increase in anticipated inflation expectations. If Japan moves to a 2% and then 4% it looses credibility. But if BoJ goes hard at 4% today, it increases the duration of the short-run (probably) and thereby reduces the probability of tail risks in your post.
All said and done, I really like the Mundell-Tobin “descriptive” way of looking at things (though talk about Cam 2000 optimizing model to the same effect). Inflation decreases financial wealth, other things equal, which decreases money demand, increases velocity and hence encourages capital creation and a fall in real interest rates.
I worry however that increases in velocity will have funny, nonlinear effects under an inflation-targeting system with current expectations. Interested in all of your thoughts..”
A followup on that last point is the adoption of a healthy NGDP target. And another worry that emerges is the international considerations of Mundell-Tobin esque analysis. Though, for an economy as large as Japan’s, I don’t know if it would matter.
Ashok: I think I’m following you.
Sidrauski’s model of long run superneutrality is my “benchmark” case. But sure, money can’t be precisely super-neutral, if currency doesn’t pay interest, and so higher inflation will cause lower real currency balances, and this can in principle affect lots of other real variables, in various ways. The Mundell-Tobin effect is one of those ways.
But my gut says that the Mundell-Tobin effect isn’t big enough to matter much, unless we are talking very large changes in inflation for countries where people use a lot of currency. Multiply currency/NGDP times the interest elasticity of the demand for currency times the change in inflation. That’s three smallish numbers multiplied together. The capital/GDP ratio will be an order of magnitude bigger. The potential for debt/GDP to crowd out capital (which is essentially the same mechanism as Mundell-Tobin) would be bigger. Not to mention the non-neutralities from nominal rigidities.
Nick, I think we principally agree, then. However, to the extent a small Mundell-Tobin effect is working, wouldn’t the risk that debt/GDP to crowd out capital significantly fall? Right now, at or near the zero bound that is obviously not the case. Inflation should just erode that, so the Mundell-Tobin would pick up over time, and the risk of crowding out should fall. If our initial premise that r < g is correct. The extension here is that it stays correct until debt becomes fundamentally manageable.
In some sense, the question here is protecting against tail risks, and the way to do that would be to make the short run, perhaps non-neutral, period as long as possible. The best way to do this is to maximize change in inflationary expectations: target NGDP or 4% inflation (I mistakenly said 4% rates).
But let’s say we’re in DeLong’s medium run where expected real yields are increasing. By definition we’re no longer at the zero lower bound, which means an unexpected monetary base expansion can also trigger Mundell-Tobin like effects (without the contingent “credibly commit to irresponsibility” clause we have today) and provide the economy breathing room, though it seems we both doubt this is very likely.
All said, however, the number of feedback loops in this mechanism does challenge my confidence..
You may be right about the future, but I doubt there were many people willing to buy JP bonds in the last 2 months, unless they were offered a discount, while the currency was consistently plunging and the authorities were cheering at the plunge asking for more. Anyway I agree with your broader point & Outlook. Good post! (By the way, could you send me an email address where I could send you an original idea, and ask for your opinion? It’s only 795 words.)
PierGiorgio: Nick dot Rowe at Carleton dot ca. No promises I will read it and respond though.
This email address does not work right now. But I see it’s the same you use at your university so I’m puzzled.
Hmm. I just tried it, and it worked for me. Did you remember the e in Carleton?
Yes I did. I sent you now the mail from another server, hope it works. Lmk.
G