Staying Positive About Going Negative
Just over two weeks ago, the Bank of Japan (BOJ) cut the (marginal) deposit rate that it pays to banks from zero to negative one-tenth of one percent. Following the BOJ’s change in policy, Japanese equity indices fell and the yen appreciated against a number of other currencies. In this post, I suggest that these effects are, at least in part, due to the BOJ’s prior negative communications about negative rates. I argue that, in light of the BOJ’s experience, the Federal Reserve should immediately begin to communicate morepositively about negative rates.
In a press conference in early December 2015, Governor Kuroda said that the BOJ was not intending to use negative rates, even though many observers were concerned about the low Japanese inflation outlook. On January 21, 2016, Governor Kuroda told the Japanese parliament that the BOJ was not planning to go negative, pointing to unstated “cons” of such a move. Eight days later, the BOJ did in fact go (slightly) negative. The BOJ’s monetary policy statement communicated that it had made this move in order to forestall general risks from abroad, and from the Chinese economy in particular.
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I see the combination of these negative messages as at least partly responsible for the outsized and adverse changes in Japanese financial conditions over the past two weeks. Even as late as January 21, the BOJ’s words and actions communicated a clear distaste for negative rates. Given that apparent distaste, the Bank’s highlighting of international risks in its monetary policy statement suggested that those risks were, in fact, quite dire. The decision to go negative also seemed to carry a latent message that the BOJ had lost at least some confidence in the efficacy of expanding its quantitative easing program.
To be clear: my intention is not to engage in (pointless) second-guessing of the BOJ’s communication strategy. (Indeed, I would argue that a number of Policy Board members are among the best communicators in global central banking.) My goal is to suggest that the BOJ’s experience has some key lessons for the Federal Open Market Committee (FOMC) here in the US.
The FOMC is currently targeting a range of a quarter to a half percent for the fed funds rate. In response to a sufficiently adverse shock, it can cut this range by twenty-five basis points To provide further accommodation beyond this twenty-five basis point cut, the Committee has to turn to other tools. There have to be plausible scenarios in which the FOMC would, in fact, very much want to turn to negative interest rates.
But its prior communication has to set up that decision. The Committee can’t convey that it sees big costs or concerns with negative rates. These kinds of communications create the risk that any decision to go negative would carry the signals I’ve discussed above (that is, the macroeconomic situation is more dire than previously communicated and the Committee lacks confidence in its other methods of providing stimulus).
How then should the FOMC communicate about negative rates? The messaging from Committee leaders should be relentlessly positive. It is reasonable to highlight that Federal Reserve staff are studying whether negative rates would in fact stimulate aggregate demand in the US, given the ability of banks and others to substitute into cash. (After all, most of us thought until about two years ago that going negative would have essentially no effect on aggregate demand given those substitution possibilities.) But FOMC leaders should be clear that, as long as negative rates do have a stimulative effect, the Federal Reserve is more than willing to use them as a monetary policy tool.
There is room for considerable improvement on this dimension in the current FOMC communications about negative interest rates. For example, Vice-Chair Dudley said on Friday that it was “extraordinarily premature” to discuss negative interest rates as a tool. The Vice-Chair largely accomplished his primary short-run goal of signaling confidence in the strength of the US economy. But the subtext of his remarks – which was probably text to many – is that negative rates are not a desirable tool. If not corrected soon, that message could well come back to haunt the Committee.
Rochester, NY, February 15, 2016
P. S. My conclusion from this WSJ article was that the Fed does have the ability, under existing statute, to implement a negative target range for the fed funds rate. I agree with the author of the article that such a move would not be without controversy. Of course, that is not new ground for the Fed – for example, the Volcker fight to contain inflation was met with a great deal of criticism.
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