Monday, March 2, 2015

What's the Actual Lower Bound?

Economists had believed that it was effectively impossible for nominal interest rates to fall below zero. Hence the idea of the "zero lower bound." And they had a good reason for believing that. Currency pays a zero nominal interest rate -- that is, a dollar bill today is a dollar bill tomorrow, no more and no less --  and therefore any attempt to lower interest rates on bank deposits below zero will merely result in depositors withdrawing their money and putting it into currency.

Well, so much for that theory. Interest rates are going negative all around the world. And not by small amounts, either. $1.9 trillion dollars of European debt now carries negative nominal yields, and the overnight interest rate in Swiss franc is around -1 percent annually.

How can we make sense of that? If people aren't converting deposits to currency, one explanation is that it's just expensive to carry or to store any significant amount of it. Therefore, the true lower bound is some negative number: zero minus the cost of currency storage.

You're only better off cashing out your bank deposits when the deposit rate is larger than the cost of storage.  For example, if it costs you 2 percent annually to store your money in currency, you'll keep your money in the bank even if the bank charges you 1 percent annually.

That's what Greg Mankiw was getting at when he said this great line about the effects of negative nominal interest rates: "[T]he only thing you’ll generate is a demand for safe assets — and by that I mean...they’re going to be buying a bunch of safes so people can put their money in their safes rather than in the bank."

But nobody really seems to have a good handle on what the new, negative lower bound might be. So how much would it actually cost, I wondered, to store $10,000 in currency for a year?

This seems to me a decent, and admittedly entertaining, way of getting a rough estimate of a lower bound. I picked $10,000 because it's about twice the average balance of a savings account in the U.S., giving me a conservative estimate of the average percentage cost.

A safe deposit box at a bank seems to cost around $100 a year after insurance. Then the average cost of storing currency is about 1 percent annually -- maybe a bit more if you buy a safe.

Yet, rather obviously, having $10,000 in a deposit box is not the same thing as having $10,000 in a bank account. You can spend from your bank account using a credit card, or you can go to an ATM and withdraw cash. You can't do the same with a safety deposit box.

How much is that convenience worth? It seems like a hard question, but we have a decent proxy for that: credit card fees, counting both those to merchants and to cardholders. That's because the credit-card company is making exactly the same calculus as we are trying to make -- how much can we charge before we make people indifferent between currency and credit cards? The data here suggest a conservative estimate is 2 percent annually.

So my rough guess is that the average depositor is probably better off keeping their money at a bank up to a nominal interest rate of -3 percent annually. (This is also what other people said, in an extremely informal poll, would be the most they would accept.) But, from an economic perspective, what we really care about is the marginal depositor -- that is, who has the lowest cost of currency storage?

And here, I am at a loss. Are there are efficiencies of scale in currency storage? What does the marginal cost curve for currency storage look like?

Would banks, in response to persistently negative nominal interest rates on deposits, increase the amount they keep in currency in vaults? Or would investors start bidding up the price of any asset that can function as a store of value and try to find ways to make their holdings function more like liquid deposits? Do companies start doing weird things with inventories and working capital?

Sunday, March 1, 2015

Assorted Links

1. Could air pollution be the first environmental issue to pierce the "development first, democracy later" agenda of China? Here's some solid new evidence that air pollution hurts infants and holds them back for the rest of their lives. Via Brad Plumer, it's also an issue in India.

2. "I find that affirmative action sharply increases the black share of employees, with the share continuing to increase over time...Strikingly, the black share continues to grow even after an establishment is deregulated."

3. Real, lasting reductions in the incarcerated population will take much more robust programs that ease the transition back to into the labor market.

4. Is "housing lock" real? Yes: "A decline in home equity is associated with large and statistically significant reductions in household mobility. A rise in the LTV ratio from 90 to 115% is associated with a 30% decline in household mobility." No: Henry Farber and Rob Valletta.

5. How, in 1967, Reagan changed the purpose of America's public universities. Also, check out this older piece by Aaron Bady and Mike Konczal about how that historical moment started the shift towards ever less state funding.

From Japan to Switzerland

How do big shocks to the exchange rate affect stock prices? We can look at two recent examples: the devaluation of the Japanese yen under the Kuroda regime shift and Jordan's de-pegging of the Swiss franc.

As the Japanese yen has dropped, the Nikkei has soared. That's not just a story of two broadly matching trends, either. The relationship holds strongly on a day-to-day basis, suggesting that whatever's driving the yen down is also driving the Nikkei up.

I think the first thing to ask with Japan is: Has it always been this way? To retell the conventional story, Japan has struggled with persistent deflationary pressures and a rising yen. Maybe it's the case, then, that whenever markets saw the yen weakening, they also became excited about the prospects of Japanese companies, particularly exporters?

Or we could tell a similar story that says this really isn't about exporters gaining from a weak yen to undercut competitors in foreign markets and pocket some profits. Pretend, for a moment, that all Japanese companies did was export and price goods in the local (i.e. export-destination) currency, and they didn't increase production or profit margins or gain market share. Then if the yen depreciated, and input prices didn't change, we should expect profits to rise passively one-for-one in yen, but stay flat in other currencies. What's merely going on is that when the Japanese exporters repatriate foreign profits, they will do so into a devalued currency.

But wait, there's more. The Bank of Japan's regime change has set off a wave of capital flows, both into and out of Japan as well as within Japan and among Japanese asset classes. For example, Japanese retirees sitting on portfolios of government bonds have seen yields come crashing down, and they have responded with some combination of pouring into Japanese equities and getting their money out of yen-denominated assets.

The first two stories seem to require the relationship between the yen and the Nikkei to be an "always-and-everywhere" thing. That is, it's not clear why a cheap yen would only sometimes help exporters, and not other times. Similarly, the passive repatriation story should always hold. But the third story is really about a third cause, a single event, behind these two patterns.

So let's take this to the data.

It turns out that the link began in 2007 -- a time when things were going the other way, that is, the Nikkei was falling on the days the yen was appreciating. There doesn't ever seem to be much of a sustained pattern before then, but maybe somebody who knows Japan better than I do can make something intelligent out of the squiggles of the 1980s and 1990s.

I think this puts a lot of doubt into the first and second stories, which is surprising to me, because both make a lot of sense! It's quite believable the Japanese yen is really just the repatriation currency for countries that do business elsewhere or that Japanese exporters benefit from a weak yen, although admittedly input prices is a bit of a problem for that story.

We should also take a look at the value of the coefficient: It's around, maybe a bit less than, one. That might actually work with the repatriation story. But hold on a second. If you look at the cumulative change in the yen and in the Nikkei, what you get is a 2-for-1 relationship. That is, for every one percent decline in the value of the yen against the U.S. dollar, Japanese equities rise 2 percent. And that would require more than the repatriation effect.

So my read of the Japan situation is that the relationship between the yen and the Nikkei is a historically contingent one that has emerged from two big waves of capital flows, the 2008 risk-off amid the financial crisis and then the 2012 Kuroda shift. The other stories don't fit the data.

Now onto Switzerland. On January 15, the Swiss central bank suddenly announced it would stop defending a currency floor that kept the Swiss franc from appreciating beyond 1.20 franc to the euro. The basic reason, the data suggest, is that it did not want to keep expanding its balance sheet. That day the Swiss franc appreciated nearly 20 percent against the euro.

What happened to stocks? As this chart from Markus Brunnermeier shows, they fell a bit less than the currency rose:

Brunnermeier focuses here on the Swiss financial sector, which handled the Swiss franc's sudden rise about as well as the broader economy. We might also break out companies in the index that are particularly focused on foreign markets, such as Swatch, Credit Suisse, Nestlé, Roche, and Novartis. They also seem to have dropped somewhat less than the rise in the Swiss franc. In fact, if you look at a currency-hedged index of Swiss equities, that rose sharply on the day of the de-pegging.

The advantage of Switzerland as a case study is that the appreciation was unanticipated, whereas in Japan, the whole point was to shout it from the rooftops. This shuts off the capital-flows story and leaves us with the two export-oriented ones. It doesn't seem likely the Swiss exporters were very much disadvantaged -- despite their complaints -- if Swiss equities rose when converted to other, more stable currencies. What it fits, rather, is the passive repatriation story: Swiss exporters' profits fall in Swiss franc when the franc rises because every dollar of foreign profits is worth less in Swiss franc than it was before. Another reason why it might not be surprising that Switzerland seems to fit that story: Switzerland is a vastly more export-heavy economy than Japan. Its exports-to-GDP ratio was 72 percent in 2013, as compared to Japan, which stood at 16.2 percent of GDP in 2013.

While Japan and Switzerland both fit the same pattern -- currency up, stocks down; currency down, stocks up -- the patterns emerged for distinct reasons. For Japan, it was the coordination of capital flows, whereas for Switzerland, the explanation seems to be that exporters would have to repatriate profits at a punishingly high exchange rate.

Saturday, February 28, 2015

Assorted Links

This blog is back. Now that I am in my junior spring, and life is a bit more under control, posting will begin again. I've missed this enormously. The balance of topics may shift a bit, but I'll let that emerge organically. A substantive post later today, but for now, some links:

1. In Scotland and Northern Island, private banks issue banknotes. (News to me.)

2. "I find that private securitization substantially increases foreclosure probability and decreases modification probability for delinquent loans."

3. Economists think a Greek default would be a big gamble with a highly uncertain payoff.

4. Lots of good new data on FRED. The elasticity of sub-minimum wage employment with respect to the federal minimum is much higher than I would have guessed.

5. The theologian John Hull on blindness, a short film from his tape recordings. Haunting.

6. YouTube channel putting together weekly education videos on World War I, via Reddit.

7. The next shoe to drop in the oil-price decline is panic among the petroleum-engineering departments of universities. See here, here, and here. Useful counter-evidence to the conventional wisdom that a dynamic global economy (or insert buzzword) increases the need for vocational, specialist, or technical education. It does the opposite.

Thursday, January 29, 2015

The Deflation Coin Flip

By my reckoning, there is now about a 50-50 chance the U.S. sees deflation in 2015, as measured by the year-over-year percentage change in the headline personal consumption expenditures price index, the measure favored by the Federal Reserve.

Above, you see my point estimates from a basic econometric model -- I've just taken headline and core PCE and the monthly average Brent crude spot and put them into a vector autoregression. The forecast was done on monthly log changes and then summed up to get year-over-year results. (This is an update of my earlier forecast here.)

In the next few months, I expect to see an abrupt disinflation, as lower oil prices feed into the price index. That will be followed by a few months of hovering at zero, with a bottoming in the summer. And then we will have a few months of inflation rising quickly back to normal.

That is contingent upon oil prices staying about where they are. Remember: If it's just a change in the level of oil prices, we will see a U-shape pattern in inflation, as we saw in 1986, 2008, and 2011. One implication of this is that we should not treat the decline in inflation as highly relevant for macroeconomic policy.

Another implication, though, is that it will be critical to keep a focus on some measure of core prices. Anticipating some pass-through from energy prices, any substantial move in core inflation would be unexpected and concerning, particularly in light of the recent decline in inflation breakevens.

Friday, January 9, 2015


I've just returned from a long trip to Malaysia as a member of Princeton's delegation to the World Universities Debating Championship, which Kuala Lumpur hosted this year.

I managed to take this panoramic shot of the city's skyline from Lake Titiwangsa, which was left behind by an abandoned open tin-mine pit and is now situated in a park to the north of the city center. A full-size copy of the image can be found here, and I release it into the public domain.

It was an amazing opportunity and great privilege to go, although perhaps not at the best time. The AirAsia flight went down two days after I arrived, and the country was in mourning. Beyond debate, I also learned an enormous amount as an economist -- just observing an East Asian developing economy firsthand was invaluable.

I'll try to put together some thoughts over the next few days if people are interested. As a start, I found this comparison helpful: Malaysia's GDP per capita, adjusted for PPP, is now about about a third of that of the US, making it comparable to Mexico today or South Korea in the mid-1980s.