4 ms·

But over the last while we've had negative nominal interest rates. This is impossible in a deflationary environment and so one problem in a deflationary enviro

by YZF 12y ago

But over the last while we've had negative nominal interest rates. This is impossible in a deflationary environment and so one problem in a deflationary environment is that the central banks can't use things like QE or lower interest rates to stimulate spending or investment. The other thing is that from a behavioral/psychological perspective having an inflation of 1.5% with interest rates at 2% doesn't feel the same as having an interest rate of 0% with a deflation of 0.5%. In the latter people are probably going to be spending less/waiting for prices to come down. [EDIT: Your salary example is the same effect. It's basically loss aversion. Either loss of income when your salary is decreased or loss of $ when paying more for something today than it will cost tomorrow. The fact that your salary reduction may be less than deflation or that what you're paying is more than if you'd invest doesn't matter to the way our minds treat loss, unless we try to trick it]

yummyfajitas 12y ago
QE does not fail when interest rates are zero. Further, there are a variety of tools the central bank can use besides interest rate manipulation. See the blog of Scott Sumner - he covers this in extensive detail. http://en.wikipedia.org/wiki/Nominal_income_target http://en.wikipedia.org/wiki/Nominal_income_target From a behavioral/psychological perspective, interest rates seem more likely to affect consumption choices. All of Keynesian and monetarist economics is predicated on the idea that people are ignorant of real prices and focus on nominal prices. So 2% nominal interest - 0.5% inflation looks like a 2% rate of return (invest more!) whereas 0% interest + 0.5% deflation looks like a 0% rate of return (consume more!). [edit: the salary example is NOT loss aversion. If you lose your job for $100, and turn down a job paying $90, you "lose" $100. If you accept the job you "lose" $10.]
- bokonist 12y ago
  Scott Sumner is wrong about the impact of QE. Read Winterspeak and Warren Mosler. Or just use simple logic. How does QE improve the balance sheet of the average person? All it does is swap one piece of government paper for another piece. If my balance sheet is not improved, why would I spend more money and drive up the prices of goods? QE does lower interest rates. If lending is limited by interest rates, than QE could increasing lending. But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact.
  - YZF 12y ago
    As long as interest rates are above 0% QE pumps money into the system. If you bought a 10% yield 10-year bond last year and that yield went to 0% it means you can sell that bond today for the same price you'd get in maturity. So that's a pretty good deal. The government or the central bankers are basically giving free money to bond holders on the assumption they will go use that money to stimulate the real economy. I think the last few years prove that it works to some degree but definitely a lot of that money gets stuck in various places, e.g. the banks. During QE the central bank can also acquire other assets that are riskier than bonds and take risk off other people's balance sheet, again hoping that money will be used to stimulate the real economy. At 0% it pretty much stops working. Up to 0% some bond holders are still holding on because they are betting on that being the better investment. The other problem is how do you exit QE. We're going to find out how that works over the next few years...
    - dllthomas 12y ago
      QE pumps money into the system, but in exchange removes something that's very nearly money. I honestly have no clue as to the overall size of the effect - really big X times a really small y could wind up just about anywhere.
  - yummyfajitas 12y ago
    QE is not intended to "improve the balance sheet of the average person". I have no idea why you think it should. But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact. You are correct - at a certain point there are no investments with a positive real rate of return. At this point all further resources should be devoted to consumption regardless of time preferences (interest rates). If consumption desires are also completely satisfied, then you are in a post-scarcity economy. Almost by definition [1], when you reach that point, you are NOT in a recession. What's the relevance? [1] The technical definition of a recession is 2 quarters of negative growth, but for theoretical purposes it generally means a period when real resources are not fully utilized.
- YZF 12y ago
  Once bonds yield 0% in a deflationary environment why would anyone hold on to bonds vs. cash? So QE means the government buys it's own bonds and that's about it. I'm talking about the long term rates, not the inter-day rates. Japan has sort of been in this situation and I think they even tried giving money to people and that didn't spur inflation/consumption. The salary loss aversion I'm talking about is taking a 10% pay cut in a deflationary environment vs. not getting a raise in a zero inflation environment or getting a raise smaller than inflation in an inflationary environment. The pay cut is going to feel much worse. That's loss aversion. From my exposure to behavioral economics through Dan Arieli I'd say the real loss of $1 is going to feel a lot worse than the nominal loss of $1 eroded by inflation. The latter feels like nothing which is why governments can use inflation as a tool so effectively. The imagery of high inflation is of people rushing with their bags of money to spend it before it becomes worthless... I've lived through some periods of high inflation and when interest rates were at over 10% I don't recall people rushing to invest, they rush to spend...
  - msandford 12y ago
    If the interest rate was below the inflation rate, then you're in a negative real interest rate environment and the rational thing to do is to spend. If the interest rate is above the inflation rate then the rational thing to do is invest. At least with whatever discretionary income you have. If the real interest rate (not the nominal one) is over 10% you can double your money in about 7 years, which is a fantastic proposition.

by YZF 12y ago

yummyfajitas 12y ago

QE does not fail when interest rates are zero. Further, there are a variety of tools the central bank can use besides interest rate manipulation. See the blog of Scott Sumner - he covers this in extensive detail. http://en.wikipedia.org/wiki/Nominal_income_target http://en.wikipedia.org/wiki/Nominal_income_target From a behavioral/psychological perspective, interest rates seem more likely to affect consumption choices. All of Keynesian and monetarist economics is predicated on the idea that people are ignorant of real prices and focus on nominal prices. So 2% nominal interest - 0.5% inflation looks like a 2% rate of return (invest more!) whereas 0% interest + 0.5% deflation looks like a 0% rate of return (consume more!). [edit: the salary example is NOT loss aversion. If you lose your job for $100, and turn down a job paying $90, you "lose" $100. If you accept the job you "lose" $10.]

bokonist 12y ago
Scott Sumner is wrong about the impact of QE. Read Winterspeak and Warren Mosler. Or just use simple logic. How does QE improve the balance sheet of the average person? All it does is swap one piece of government paper for another piece. If my balance sheet is not improved, why would I spend more money and drive up the prices of goods? QE does lower interest rates. If lending is limited by interest rates, than QE could increasing lending. But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact.
- YZF 12y ago
  As long as interest rates are above 0% QE pumps money into the system. If you bought a 10% yield 10-year bond last year and that yield went to 0% it means you can sell that bond today for the same price you'd get in maturity. So that's a pretty good deal. The government or the central bankers are basically giving free money to bond holders on the assumption they will go use that money to stimulate the real economy. I think the last few years prove that it works to some degree but definitely a lot of that money gets stuck in various places, e.g. the banks. During QE the central bank can also acquire other assets that are riskier than bonds and take risk off other people's balance sheet, again hoping that money will be used to stimulate the real economy. At 0% it pretty much stops working. Up to 0% some bond holders are still holding on because they are betting on that being the better investment. The other problem is how do you exit QE. We're going to find out how that works over the next few years...
  - dllthomas 12y ago
    QE pumps money into the system, but in exchange removes something that's very nearly money. I honestly have no clue as to the overall size of the effect - really big X times a really small y could wind up just about anywhere.
- yummyfajitas 12y ago
  QE is not intended to "improve the balance sheet of the average person". I have no idea why you think it should. But at a certain point, interest rates are low enough that lending is limited by the lack of creditworthy borrowers or by bank capital requirements, and so further reductions will have very limited impact. You are correct - at a certain point there are no investments with a positive real rate of return. At this point all further resources should be devoted to consumption regardless of time preferences (interest rates). If consumption desires are also completely satisfied, then you are in a post-scarcity economy. Almost by definition [1], when you reach that point, you are NOT in a recession. What's the relevance? [1] The technical definition of a recession is 2 quarters of negative growth, but for theoretical purposes it generally means a period when real resources are not fully utilized.
YZF 12y ago
Once bonds yield 0% in a deflationary environment why would anyone hold on to bonds vs. cash? So QE means the government buys it's own bonds and that's about it. I'm talking about the long term rates, not the inter-day rates. Japan has sort of been in this situation and I think they even tried giving money to people and that didn't spur inflation/consumption. The salary loss aversion I'm talking about is taking a 10% pay cut in a deflationary environment vs. not getting a raise in a zero inflation environment or getting a raise smaller than inflation in an inflationary environment. The pay cut is going to feel much worse. That's loss aversion. From my exposure to behavioral economics through Dan Arieli I'd say the real loss of $1 is going to feel a lot worse than the nominal loss of $1 eroded by inflation. The latter feels like nothing which is why governments can use inflation as a tool so effectively. The imagery of high inflation is of people rushing with their bags of money to spend it before it becomes worthless... I've lived through some periods of high inflation and when interest rates were at over 10% I don't recall people rushing to invest, they rush to spend...
- msandford 12y ago
  If the interest rate was below the inflation rate, then you're in a negative real interest rate environment and the rational thing to do is to spend. If the interest rate is above the inflation rate then the rational thing to do is invest. At least with whatever discretionary income you have. If the real interest rate (not the nominal one) is over 10% you can double your money in about 7 years, which is a fantastic proposition.