negative interest rates

ECB unprecedented move on negative interest rates

This seems part of the "low political cost" policy recommendations from Krugman and others to take strong unorthodox measures to boost aggregate demand, to get the economy going back to growth from its rut. Read my posting on the Krugman talkbi attended here: /khoryuleng/2014/05/krugman-on-need-for-growth.html. Thus this might seem a belated move to many such economists.

I just had dinner with a friend who's a senior KL banker. She's a bit worried in the shorter term that the VIX volatility index is low, indicating market complacency. We talked about how it seems necessary to boost aggregate demand for employment creation and such; but the low rates policy of the last few years has just fed into non-productive sectors such as financial trading and investment, property and the like with nary a curb on the property sector in many countries. Thus, in Malaysia it seemed a good thing that BNM has been trying to curb the property sector - albeit with some major developers trying to be exempted e.g. in Iskandar Malaysia (here, there is talk of higher price hurdle for foreign buyers but I wonder if big property project owners will allow that).

I'm just a bit concerned about the unintended consequences of what is seemingly the extension of a well-intended policy. Policy making seems controlled by political-rich business interests. They have seemed hardly inclined to put in holistic policies to funnel all the QE money into the right direction. Are they doing things any differently this time with negative rates? The market neo-liberal hegemony is pretty strong.

I've been reading the latest Michael Lewis book, "Flash Boys" that talks about how smart people in the financial sector play and direct regulations to their benefit. I've been analyzing sustainability certification in commodity supply-chains - this is also another regulation that gets linked up with commercial interests. Regulations of increasing complexity benefit those who are able to figure them out and work them to their benefit i.e. mostly the richer companies. Do we end up with a better world as a result of this? In food regulation, I just read a Time.com piece that said that business interests have managed to get pizza defined as a vegetable in the US! Read this: How Sugar Went From a Condiment to a Diet Staple http://time.com/2812756/how-sugar-went-from-a-condiment-to-a-diet-staple/.

The common feature in all of this: well-intended policies seem to just keep getting hijacked by interest groups and big business. The outcomes end up rather unexpected if not even paradoxical.

I wonder whether this extension of a less than successful economic policy will get us nice job creation for the man in the street or whether it's just another round of asset price pumping for the rich. If the policy has not been well implemented, does escalating it work? Is the policy itself wrong? Is there a structural problem in policy making and more?

Hope it works out successfully in short time so we can get back to regular policy. Time for you all to go out and spend and invest in property, art, wine or whatever... just take your money out from the bank and get it moving ! Just so long as you're not an ageing pensioner...

Update, comment from reader who is from the Asian business sector: "yup.. we are in a crazy crazy world... borrowing money is now better than savings... the world's best brains are telling us all."

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ECB Announces Measures to Boost Bank Lending
The European Central Bank said it will introduce a series of measures designed to boost bank lending and head off dangerously low inflation, after announcing a series of interest-rate cuts.
Among the initiatives announced by ECB President Mario Draghi were targeted long-term refinancing operations, which will give banks access to low-interest-rate loans.
The euro plunged to a four-month low against the dollar after the ECB announced the package, falling 0.7% to $1.3503 from above $1.36 before the central bank's rate cuts, while European stocks rose to a fresh six-and-a-half-year high.

source: Bloomberg.com
Bloomberg.com news links:

Krugman on need for growth

Last Wednesday, I managed to get a spot at a talk of deflation risk by Paul Krugman. Skidelsky (Keynes biographer) was on the panel. The talk was led by Sanjaya Lall Foundation and Malaysia's Khazanah sovereign wealth fund had a presence. Maybe they paid for the cocktails after. I didn't have time to get enough of those smoked salmon blinis.

Krugman talked about problem of demographic and real estate drags (-4 pctage points pa on the latter) on economic growth. He seems to be painting Japan post 1980s scenario for US and perhaps more so Europe. On US data he showed how each recession needed ever lower interest rates to boost growth again (see photo), but with the previous two post recessions booms feeding into the Internet and housing bubbles. Krugman was very confident that economics knows what to do get us out of the current morass. One should be unconventional and aggressive with deep negative interest rates to force people not to save and thus boost aggregate demand (AD) for employment and growth. But he was disappointed that the politicians have not taken up this obviously low cost policy option. The dismal conclusion seemed to be that politicians and others would be too conventional and not use this simple cheap solution.

His 24 October 2013 op-ed is a good summary of his point against those who don't get it : "They just assume that it would cause soaring interest rates and economic collapse, whenboth theory and evidence suggest otherwise. Don’t believe me? Look at Japan, a country that, like America, has its own currency and borrows in that currency, and has much higher debt relative to G.D.P. than we do. Since taking office, Prime Minister Shinzo Abe has, in effect, engineered exactly the kind of loss of confidence the debt worriers fear — that is, he has persuaded investors that deflation is over and inflation lies ahead, which reduces the attractiveness of Japanese bonds. And the effects on the Japanese economy have been entirely positive! Interest rates are still low, because people expect the Bank of Japan (the equivalent of our Federal Reserve) to keep them low; the yen has fallen, which is a good thing, because it make Japanese exports more competitive. And Japanese economic growth has actually accelerated...."

The panel and Q&A did not bring strong challenge to this view. It was developed country centric. On a question on climate change, Krugman saw environmental stresses as another business opportunity to push AD. I suppose this is happening as standards imposed in developed economies and on developing nations via trade standards is growing a new sub sector of activity. But there is the argument that all this is not really changing the outlook for the environment but merely helping us more efficiently destroy the environment.

I chatted with several people about Krugman's policy views. Most talked about inequality, housing and asset bubbles. My demography professor remarked on bigger negative rates: but what would happen to aged pensioners?

An Asian businessman said: 

My concern with Krugman's prescriptions is that the world effectively goes into competitive devaluations. Imagine every major economy doing likewise. Some say that Japan needs to create excess liquidity of US$9 trillion to deflate away the fiscal debts. That's 3 times US QE. And now Euro zone talking of the same.  Surely, China will deflate too to protect exports. Then what? Yes, aggregate demand grows. But surely we fall right back into hyper inflation? The excess reserves are not yet translated into money supply. That will happen the moment agg demand expands.

Expand the pool of money even more? I don't believe in a free ride. Printing money does not sound right. Maybe I am too traditionalist. Frankly, the world has enough wealth. It has enough production. It needs to balance disparity. And it's not all that bad to allow nature a rest, from excessive exploitation. If we have enough housing stock and with less population, why keep building? We should not grow for the sake of growth. The fear of deflation is real as in Japan and maybe elsewhere. Japan was in stagflation the last 2 decades but the world grew... China, the rest of Asia etc. Europe may go into stagflation due to its population profile but Africa will grow. I think the agendas are different. It's about western growth by exporting on devalued currencies.

Bottom line: Krugman says we are in unprecedented depression economics. But others ask if we are too addicted to growth and bubble cycle and beggar thy neighbour policies?