Another Jackson Hole economic symposium has come and gone. Fed Up, a group that's pushing for lower rates and asking the Fed to pay more attention to minorities and workers, is thrilled that it got some limelight. Former Treasury Secretary Lawrence Summers is disappointed that the conference didn't spur more of a monetary policy rethink.
But as the dust settles in Wyoming, the shindig is leaving behind at least one legacy: new research about the future of monetary policy.
In this week's roundup of economic studies, we look at two of the most-talked-about Jackson Hole papers — one suggests that the Fed balance sheet should stay big for financial stability reasons, while the other sounds the death knell on the zero lower bound. To mix it up, we'll also take a look at female legal equality in economies around the world, then summarize Goldman Sachs's new effort to quantify how much easing in the rest of the world is responsible for the big decline in 10-year U.S. Treasury yields.
The Federal Reserve’s Balance Sheet as a Financial-Stability Tool
Author: Robin Greenwood, Samuel Hanson, and Jeremy Stein
Maybe Fed balance sheet unwinding should never come to pass, if you ask this trio of Harvard University professors, which includes former Fed Governor Stein. They argue that the central bank could keep banks from engaging in risky behavior by keeping the Fed’s holdings large – albeit, after winding down mortgage-backed security holdings and reducing the weighted average maturity of its Treasury holdings. The idea is that the Fed remains a major extender of overnight reverse repurchase agreements. In this transaction, the Fed takes an overnight cash loan from the financial system using bonds from its portfolio as collateral. Creating lots of short-term, government interest-bearing claims crowds out private-sector claims. What's good about that? The authors argue that if the financial system issues too many runnable private short-term claims to finance longer-term risky assets, that poses a "key threat to financial stability." By expanding the overall supply of safe short-term claims, "the Fed can weaken the market-based incentives for private sector intermediaries to issue too many of their own short-term liabilities,'' they say.
This paper was the most-discussed at Jackson Hole, Bloomberg's Steve Matthews and Jeff Black found in a straw poll of economists.
The Case for Unencumbering Interest Rate Policy at the Zero Bound
Author: Marvin Goodfriend
In another big paper presented at Jackson Hole, Carnegie Mellon economist Goodfriend does exactly what the title says — makes the case for ensuring that negative nominal interest rates are available and effective as a policy option in a future crisis, in a world where market rates have drifted much lower. “The problem for monetary policy is that low long term nominal rates leave little or no room for the usual cyclical fluctuations of short term nominal rates below long term nominal rates over the business cycle,” he writes. “First and foremost, the zero interest bound should be removed” in order to ensure future price stability, he writes, equating it to the gold standard in the twentieth century. The zero boundary is the term economists use to note that a central bank has difficulty reducing its policy rate below zero in nominal terms, that is, before adjustments for inflation.
Goodfriend warns that quantitative easing — where central banks buy bonds and inject money into banks — leads to the assumption of credit risk and maturity transformation that amount to “taking risks on behalf of taxpayers, and all moving central banks ever closer to destructive inflationary finance." Negative rates interest rates — where a central bank overcomes the zero boundary by having holders of its claims pay instead of receive interest — don’t risk such distortions. Still, he acknowledges that in the U.S. “long-standing institutional arrangements” under which the Fed doesn’t charge for cash deposits could make negative rates untenable in the longer-term, because investors could exit securities in favor of cash. To prevent that, Goodfriend offers some pretty ambitious options, such as abolishing paper currency. More on the paper here.
Unequal Before the Law
Author: Sarah Iqbal, Asif Islam, Rita Ramalho, Alena Sakhonchik
This World Bank study examines the degree to which women face legal disparities across 167 different countries. Looking at 71 possible disparities — including "is there a difference in the age at which a man and a women can retire and receive full benefits?" and "does the law mandate nondiscrimination based on gender in hiring? " — they find that countries have an average of 17 legal differences between genders. Higher degrees of disparity come alongside lower years of education relative to men, lower labor force participation rates relative to men, and a smaller proportion of women who are top managers.
The country with the smallest gender legal gap? The Slovak Republic, which scored only a 2. On the opposite side of the spectrum, Saudi Arabia scored nearly a 50, while Iran scored 44 and Yemen scored 41. The U.S. ranked 32 out of the 167 nations studied, while the U.K. came in 16th overall.
Unconventional Easing Travels Abroad
Author: Goldman Sachs economists
Available: to Goldman Sachs clients
The Goldman team takes a look at how unconventional easing policies abroad are affecting yields in the U.S., and find that the Eurozone in particular is having an impact – with ECB rate expectations lowering the U.S. term premium by about 35 basis points, and ECB asset purchases subtracting another 20 basis points. (Definition: it takes a hundred basis points to make 1 percentage point.)
Based on the Goldman finding, Bank of Japan easing has reduced term premium in the U.S. by 30 basis points in total, while Bank of England easing cut 12 basis points from U.S. rates. Together, easing in Group of Four economies accounts for almost 100 basis points of the reduction in the 10-year Treasury yield since the end of 2013.
Why is this happening? "Over the last two and a half years, every G-10 central bank has eased monetary policy except the U.S.," the researchers write. "In our view this has likely lowered bond yields in the U.S. as investors have substituted out of lower-yielding markets." The effect from unconventional policy is greater than that of standard interest rates cuts, they say. While lower domestic short-term rates make foreign yields more attractive, they also make currency hedges more expensive – investors pay the spread between foreign short-term rates and domestic short-term rates to hedge exchange rate risk. With QE or forward guidance, that offset doesn't happen, because bond yields are lowered without widening the gap between domestic and foreign short-term rates.