Banks & Interest Rates Archives - Page 47 of 59

November 18, 2012

The Liquidity Trap

In his 2003 paper Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others Lars E.O. Svensson describes the liquidity trap experienced by countries such as Japan and lately the US, when central bank interest rates are close to zero percent.

If the nominal interest rate is initially low, which it is when inflation and expected future inflation are low, the central bank does not have much room to lower the interest rate further. But with deflation and expectations of deflation, even a nominal interest rate of zero percent can result in a substantially positive real interest rate that is higher than the level required to stimulate the economy out of recession and deflation. Nominal interest rates cannot fall below zero, since potential lenders would then hold cash rather than lend at negative interest rates. This is the socalled “zero lower bound for interest rates.”
In particular, conventional monetary policy seems unable to provide sufficient stimulus to the economy and address recession and deflation once the zero lower bound for interest rates has been reached. The problem is that the economy is then satiated with liquidity and the private sector is effectively indifferent between holding zero-interest-rate Treasury bills and money. In this situation, standard open-market operations by the central bank to expand the monetary base by buying Treasury bills lead the private sector to hold fewer Treasury bills and more money – but this has no effect on prices and quantities in the economy. When this “liquidity trap” occurs, expanding liquidity (the monetary base) beyond the satiation point has no effect. If a combination of a liquidity trap and deflation causes the real interest rate to remain too high, the economy may sink further into a prolonged recession and deflation.

November 16, 2012

Fed monetary policy

I read this excerpt from a speech by Ben Bernanke in September (courtesy of Cullen Roche):

The tools we have involve effecting financial asset prices. Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other interest rates, corporate bond rates. Also the prices of various assets. For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is one vehicle. Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend. One of the main concerns that firms have is that there is not enough demand… if people feel their financial position is better… they’ll be more likely to spend, and that’s going to provide the demand firms need in order to be willing to hire and to invest.

It stopped me in my tracks. Here is why:

The Fed Chairman avoids stating the obvious: there is only one aim of monetary policy: to increase or decrease the amount of debt in the economy. Their tools are designed to encourage people to borrow more — or occasionally less, when the results of their earlier policy materialize.
Raising prices to increase demand? Raising home prices is unlikely to clear inventories of unsold homes or stimulate the construction industry.
What Bernanke is referring to is known as the “wealth effect” — raising asset prices by lowering interest rates stimulates spending. The “wealth illusion” would be a more appropriate name.
Rising asset prices make people more willing to spend. He is 100% correct here. But he fails to mention the resulting asset bubble that follows. Low interest rates and rising prices feed speculation….. which lead to higher prices and more speculation….. which lead to a self-reinforcing spiral.

Economics is not a hard science like engineering or physics, where one can accurately gauge outcomes. It is a soft science, like psychology, and many practitioners with competing theories as to how to treat the patient. With spectacular failure rates. Theory after theory is consigned to the waste basket as we struggle to understand the human condition.

November 14, 2012

Back to Basics: A Better Alternative to Basel Capital Rules | Thomas M. Hoenig

FDIC Director Thomas Hoenig calls for a simple capital ratio of Tangible Equity/Tangible Assets instead of the complex measures proposed by Basel III. Using Tier 1 capital measured according to Basel III standards overstates tangible equity capital by about 40 percent and using risk-weighted assets makes capital adequacy ratios even more subjective.

Prior to the founding of the Federal Reserve System in 1913 and the Federal Deposit Insurance Corporation in 1933, bank equity levels were primarily market driven. In this period the U.S. banking industry’s ratio of tangible equity to assets ranged between 13 and 16 percent, regardless of bank size……..

[Basel capital standards] led to a systematic decline in bank capital levels. Between 1999 and 2007, for example, the industry’s tangible equity to tangible asset ratio declined from 5.2 percent to 3.8 percent, and for the 10 largest banking firms it was only 2.8 percent in 2007. More incredible still is the fact that these 10 largest firms’ total risk-based capital ratio remained relatively high at around 11 percent, achieved by shrinking assets using ever more favorable risk weights to adjust the regulatory balance sheet.

via FDIC: Speeches & Testimony – 9/14/2012.

Hat tip to Barry Ritholz.

November 13, 2012

Richard Fisher | Politicians need to get their act together

Texas Fed President, Richard Fisher believes fiscal authorities need to get their act together. “There is a limit to what we can do. We can’t have a Buzz Lightyear monetary policy: to infinity and beyond.”

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Fisher’s frustration with Washington is hard to miss:

“We have to completely reboot tax policy. We need to completely reboot spending policy……..This is all about job creation…..We have to build confidence in the business community, who are the job creators. And until we give them some clarity, they are just going to hold back. If we have temporary fixes to the fiscal cliff this just pushes out the envelope of indecision…… Just get the job done. Give the business community and those who employ people — the private sector — a sense of direction and confidence. Right now they know nothing. They don’t know what their taxes are going to be. They don’t know what spending patterns are going to be. They don’t know what the costs of these massive regulatory initiatives are going to be…. No business can plan right now…..”

November 12, 2012

UK: Bank break-up an option if ring-fence fails | Vickers

Matt Scuffham and Steve Slater write:

Britain could force banks to fully separate their retail operations from riskier areas if lenders fail to implement a “ring-fence” that sufficiently safeguards taxpayers or improves behavior, the architect of the plan said on Monday.

The Independent Commission on Banking, chaired by Sir John Vickers, recommends that UK banks “ring-fence” their retail operations to protect customers from riskier investment banking activities.

Andy Haldane, the Bank of England’s financial stability director, commented last week that ring-fencing would only work if the retail operations have a separate management, pay structure and balance sheet.

via Bank break-up an option if ring-fence fails: Vickers | Reuters.

November 6, 2012

Australia: Hard or soft landing?

Browsing the latest charts from the RBA.

Despite record low 10-year bond yields…..

Housing Finances

Credit growth is subdued and likely to remain so for some time.

Credit Growth by Sector

After a massive credit bubble lasting more than a decade.

Housing Finances

Households are saving close to 10 percent of Disposable Income in anticipation of a contraction.

Housing Finances

While banks are reluctant to lend when their margins are being squeezed.

Housing Finances

Borrowing offshore is not an option. That is how we got into such a fix in the first place.

Housing Finances

Makes me believe we are unlikely to see another housing boom for some time.

There are two possible outcomes: a soft landing and a hard landing.

It all depends on whether Wayne Swan and the RBA know their jobs.

November 6, 2012

Is the Fed finally listening to Scott Sumner?

Brendan Greely writes of Scott Sumner.

Sumner who holds a Ph.D. from the University of Chicago, made a suggestion in the late 1980s to the New York Federal Reserve. He proposed that the Fed set a target for nominal GDP—real growth in GDP plus the rate of inflation. He felt that this would induce the correct level of business investment better than targeting either inflation or growth in real GDP by themselves. The response at the New York Fed, says Sumner, was, “Thanks, but no thanks.”

Targeting nominal GDP (NGDP) growth eliminates reliance on inexact measures of inflation which can mis-direct monetary policy. The advantage is that NGDP can be accurately measured. NGDP targeting would help to eliminate bubbles in the long term by restricting debt growth. And in the short-term would encourage the Fed to expand money supply in response to private sector deleveraging, avoiding deflationary pressure.

The announcement by the Fed’s rate-setting committee in mid-September doesn’t contain any mention of targeting nominal GDP. But its open-ended nature and clear goals—pump up the money supply until hiring rises strongly—resembles Sumner’s nominal GDP model, which would have a central bank do all in its power to achieve an agreed-upon nominal rate of growth.

It has taken Sumner almost 3 decades, but in the end he is likely to get there.

via The Blog That Got Bernanke to Go Big – Businessweek.

November 5, 2012

Bank of England should leave forecasting to Ladbrokes « The Market Monetarist

The Market Monetarist makes a novel suggestion as to how to avoid central banks from making biased forecasts:

“…..even better as I have suggested numerous times that the central bank simply set-up a prediction market. In Britain that would be extremely easy – I don’t think there is a country in the world with so many bookmakers. The Bank of England could simply ask a company like Ladbrokes or a similar company to set-up betting markets for key macro economic variables – such as inflation and nominal GDP. It would be extremely cheap and the forecast created from such prediction market would likely be at least as good as what is presently produced by the otherwise clever staff at the BoE.”

That could work …..until punters learn that the bets they place indirectly influence central bank monetary policy. It might pay market participants to place large bets on low or high inflation if they stand to benefit from the central bank response.

via Bank of England should leave forecasting to Ladbrokes « The Market Monetarist.

November 5, 2012

Treasury yields warn more of the same

Inflation has fallen over the last quarter-century, so one would expect to find Treasury yields have fallen, but there is more than just benign inflation at work. The Fed has also been suppressing long-term interest rates, with QE1, QE2, Operation Twist and now QE3.

10-year Treasury Yields

The yield on 10-year Treasuries is now below the Fed’s long-term inflation target of 2 percent, offering savers a negative return on investment unless they are prepared to take on risk. The Fed’s aim is to induce investors to take on more risk, in the hope that increased capital spending will stimulate employment and lead to a recovery. But they risk leading savers into another disaster, with falling earnings or rising yields ending in capital losses.

Corporations are reluctant to expand and will remain so until they see a sustainable increase in consumption. Fueled by new jobs — not short-term credit. Low interest rates without job growth could cause another speculative bubble, with too much money chasing too few opportunities.

Without jobs, no monetary policy is likely to succeed.

November 4, 2012

Nationalbanken Defends Sub-Zero Bemoaned by Banks | Bloomberg

Peter Levring and Frances Schwartzkopff write that Denmark’s central bank has taken an unusual step to defend the krone from capital inflows similar to those experienced earlier by Switzerland.

The central bank has kept its deposit rate at minus 0.2 percent since July, in an effort to fight off a capital influx and maintain the krone’s peg to the euro.

Deposits held at the central bank are charged a fee of 0.2%, rather than paid interest as in the US.

At the same time, the industry is still paying its customers to hold their deposits in an effort to attract stable funding and reduce reliance on wholesale financing. That’s turned deposit banking in Denmark into a losing business.

The measure would encourage banks to increase lending, loosening credit standards to avoid the charge on excess reserves. It would also reduce the rate paid on call deposits, while increasing bank competition for more stable time deposits.

via Nationalbanken Defends Sub-Zero Bemoaned by Banks: Nordic Credit – Bloomberg.