Why are interest rates so low (I)

On the first point: no idea. In fact, I never found the WR a useful concept at all; its "rediscovery" by Mike Woordford is not something I welcomed. One can always do a whole lot of hand-waving and argue that WR, as measured say by the FFrate or by the rate on T-bond of some short maturity X is a sufficient statistics for the whole collection of different equilibrium rates of return on different assets, as it is the "marginal" rate, the one equilibrating the market for riskless investment at the maturity X. The rest, one can argue, is priced by some arbitrage argument. Maybe. If we knew everything else that enters the arbitrage equations this could be done. But I very much doubt this is the case, hence I very much doubt the WR is a sufficient statistics for anything. Even IF it were well defined, which unfortunately it is not. And this is something worth insisting upon: HOW do you measure the WR in the real world and HOW do you relate it to all other rates of return?

Further, "full employment" means nothing if one does not specify the structure of the underlying markets where inputs are traded. Competitive, monopolistic, oligopolistic, whatnot ...

Which is why I believe we need to model financial markets at a disaggregated level and study monetary policy for what it is: first and foremost a mechanism through which the monopolist of liquidity affects the portfolio position of SOME financial actors (those trading in the FF market). 

Second point: very good point, I believe it did play a role in Japan and also in the US, especially when it comes to banks. It kept alive lots of banks that should have gone under. Not sure it also kept alive lots of otherwise unprofitable businesses. But it is worth writing a paper, and you should start one :)

I agree with Michele. You should start writing

I have always argued that the zero lower bound is another fantasy produced by the religious mind of the obedient macroeconomist.

... the staircase to heaven will collapse if its initial steps are weak.

What I am pointing out are those parts, in BB's basic argument, that are either unsupported or incoherent.

Speaking of which, let me re-iterate a point many have made in the past but your comment suggests to be worth repeating.

BB, and other high ranking Fed's officials, got to make up  their mind between:

(i)  Movements in the FF rate cannot affect long term real rates for a significant amount of time, and

(ii) The (achieved) goal of QE was, and is, to lower the long term real rates for a substantial amount of time.

 You cannot have your cake and eaten too.

Summing up, the incorrect inference BB wants us to believe is the following:

1) The Fed moves the FF rate to track the WR;

2) The Fed, and other central banks, have lowered both short and long term rates;

3) Hence the WR rate is low worldwide.

In the post I try to cast doubts 1).  Matter of fact, this comments also casts doubts on 2).

From which I conclude that - even assuming the Wicksellian Rate is a meaningful concept, which I very much doubt - the conlusion reached in 3) does not stand. 

Now, Ben says he sees no support for the secular stagnation argument, and I agree. Let's see where he's going. I have been arguing here and elsewhere that, in fact, we do NOT have a convincing explanation for what's going on. And he may well be, without admitting it, in my same situation: searching for an answer :) 

anch'io sono intrigato dalla 2)

 

The amount of high quality bonds in the world is finite. Financial institutions need high rating, liquid fixed income assets for their daily operations. Furthermore, financial regulations after the crisis push institutions in holding low risk assets (Basel III for Banks, Solvency 2 for Insurances). If the central banks buy government bonds through quantitative easing, an insurance will not go into equity, but will rather buy some other form of fixed income assets, preferably sovereign bonds.

 

viene ben evidenziato il ruolo del QE, attrezzo mai impiegato prima in questa misura; michele boldrin lo trascura, credo perchè più interessato all''incoerenza del ragionare di BB e alla probabile inanità di fondo di politiche monetarie molto reattive o anche pro-attive.

i nuovi criteri regolamentari per gli investitori istituzionali sono poi conseguenza dell'esplosione nucleare dei precedenti e fatalmente perturberanno ancora per parecchio il mercato. come corollario, molto lavoro per i risk-manager.

il fantomatico wr? sembrerebbe allora ben più alto, negando l'ipotesi di stagnazione secolare "estiva" :-), e prospettando prossimi adeguamenti violenti: una improvvisa crescita, magari!, oppure inflazione a manetta. 1x2, esclusa la x, insomma.

The questions you ask are difficult, not only the go beyond what one (well, me) can do by means of a comment on a blog but, more generally, they enter uncharted territories. So, just my one cent.

1) Forward guidance. Indeed, IF 

- I am CERTAIN that the nominal short rate will stay at X% for N years in all the countries I can trade,

- AND I am certain about inflation rates for the next N years in all the countries I can trade,

- AND I am certain of how exchange rates among all the countries I can trade will move during the next N years,

- AND, finally, I am also certain of how other securities (with different degrees of riskiness) will behave (along both the risk and return dimensions) in all the countries I can trade during the next N years,

THEN, the yield on the N years bond should stay at X% in the country I am currently operating.

This is BECAUSE of arbitrage (modify accordingly in the N at some power other possible cases):

should the N year bond yield more than X% in the home country (change country as needed in the N at some power other possible cases) I can borrow short term an (unlilmited?) amount at X%  in the home country each year for N years and use the proceedings to hold a long position in the N year bond, therefore making an (unlimited) amount of money for sure.

No doubt about this. Combinatorial complexities aside, this is a clear case in which arbitrage arguments deliver the result by plain arithmetic.

But, the strong assumptions I have made to state the proposition are enough to show how hard the "forward guidance" argument is to  deliver the result. 

Because reality is always somewhere in the middle of all these demanding assumptions there is no doubt that "anything can happen" and that, the stronger the common beliefs are about all those variables I listed, the more likely it is to see forward guidance working.

As you pointed out during the period you are interested in, the relevant rates gyrated around quite a bit but kept a tendency to get lower and stay low.  Somehow forward guidance had some effect, but this is far from stable and certain. Agents are nervous and uncertain, not certain, about the future ... 

And yes, I agree: currently market participants expect rates to stay low in most relevant countries, they also expect inflation not to pick up and ... well, I have no idea what they expect about exchange rates because if I had ANY clear idea about where exchange rates will go in the next few years I would  bet zillions on that and become rich (and NOT tell you!) :)

I hope this clears the matter: arbitrage arguments are powerful but market's expectations are an untamed and untamable beast. So, in any case, you are forced to take bets and if you are lucky and your bets are correct you hit riches. More than that I do not dare to say. I have my own opinions about what the Fed and the BCE will do (no idea about BofJ, have not gone there for a while) but they are just that: educated opinions ...

There is no free lunch, guidance notwithstanding.

 2) Finite size effects and institutional/regulation contraints on big players. This is also raised by dragonfly below and ... I agree with you both!

I am quite convinced that regulators are pushing many financial institutions to hold assets of a certain class, of which there are very few, and disregard lots of other options. This is because, on the one hand, regulation has become more pressing post 2008 AND, on the other hand, many banks still have very weak portfolio structures and relatively little own-capital.  This was the reason for the credit crunch that hit Spain, Italy and other countries in 2011-2014. I even said that while playing "politician" and advocating drastic re-capitalization of italian banks :)

And, indeed, I agree that the various rounds of QE, by FRB and ECB, have strenghtened this tendency. There is such a thing as "crowding out" especially when countries are, correctly, restraining themselves on the deficit side, hence the stock of "good bonds" outstanding is not increasing very rapidly while the "safety and regulation induced" demand from financial institutions is growing rapidly.

Notice, and I close here, that this whole thing has near ZERO impact on the real economy and tells us NOTHING about what the "Wicksellian Rate" is in the (risky) real investments out there, among guys taking chances in new enterpriseses. Those rates of return are NOT measured by the return on the Bund!

Well, I spoke too fast: it DOES have some effects.

Because not only the amount of safe bonds available is limited but also the amount of resources invested in bank equities is limited, the push toward safe bonds (plus QE) crowds out of the market the demand for funds from the risky guys, those that create growth.  There is not enough saving going around to finance ALSO them at reasonable rates. When you look at it from this point of view QE is actually DAMAGING for the private sector and for growth. Here is, schematically, the argument.

1) Growth comes from risky investments in the private sector; because of regulations such investments consume lots of "capital" if "banks" have to finance them and comply with Basel&Co.

2) Banks do not have unlimited capital, in fact have little capital relative to the short term liquidity available to them. And they MUST satisfy regulatory requirements, Basel and so on.

3) The amount of low risk bonds available is finite and everybody wants to have a chunk of them in the portfolio. QE also buys these bonds, hence their price goes up and returns down.

4) Because of 2) and 3) financial institutions buy safe bonds no matter how costly they are and are unable/unwilling to use liquidity to invest in risky projects, BECAUSE there is not enough capital going around banks to cover the risk of such projects.

5) In the resulting equilibrium, there is excess demand for the safe bonds, their return goes negative and lots of short term liquidity is kept hidle BECAUSE banks do not have enough equities to support a portfolio long on risky, private sector investments.

The latter go hungry and QE is part of the problem. Amen. 

Your risk, if you are a Life Insurance Company(for example) it's called "RISCHIO DI REINVESTIMENTO". Ti trovi con ricche plusvalenze(in valore nominale) che sfrutti(vendendo) per impieghi diversi(rimborsi anticipati ad esempio) ma con l'impossibilità di reinvestire (a parità di rating pregresso e rendimento pregresso) in assets che ti garantiscono la possibilità di onorare quanto promesso alla clientela. E devi assumerti rischi maggiori. Se chiedi ad un assicuratore tedesco cosa pensa di quanto sopra ti risponderà che è un problema serio..molto serio. Problema che siamo vicini ad affrontare imho poichè non vedo effetti significativi dal lancio del QE. Un reale rischio sistemico generato dall'antibiotico QE che dovrebbe, nelle intenzioni originarie, debellarlo.

Ho scritto in italiano perchè non conosco l'inglese. Mi scuso.