Download - The reversal rate - Banquedefrance
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The Reversal Interest Rate An effective Lower Bound on Monetary Policy
Markus K. Brunnermeier & Yann Koby
Safe Assets & Valentin Haddad
Princeton University
Banque de France Paris, Sept. 20th, 2016
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Motivating Questions
New Keynesian models: ZLB = Liquidity trap
Is zero special? Are negative rates special? No Ignoring headline risk
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Motivating Questions
New Keynesian models: ZLB = Liquidity trap
Is zero special? Are negative rates special? No Ignoring headline risk
Lower bound Rate at which accommodative policy becomes contractionary
(possibly due to financial instability) Does strict financial regulation reduce effectiveness MoPo?
Acceleration + brakes = reversal
What factors determines the Reversal Rate? Market structure & funding structure Banks equity Interaction with prudential regulation Interaction with QE
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& K
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Motivating Questions
New Keynesian models: ZLB = Liquidity trap
Is zero special? Are negative rates special? No Ignoring headline risk
Lower bound Rate at which accommodative policy becomes contractionary
(possibly due to financial instability) Does strict financial regulation reduce effectiveness MoPo?
Acceleration + brakes = reversal
What c determines the Reversal Rate? Market structue & funding structure Banks equity Interaction with prudential regulation Interaction with QE
Further interest rate cut iscontractionary accommodative
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Bru
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& K
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Motivating Questions
New Keynesian models: ZLB = Liquidity trap
Is zero special? Are negative rates special? No Ignoring headline risk
Lower bound Rate at which accommodative policy becomes contractionary
(possibly due to financial instability) Does strict financial regulation reduce effectiveness MoPo?
Acceleration + brakes = reversal
What factors determines the Reversal Rate? Market structure & funding structure Banks equity Interaction with prudential regulation (reversal) Expected length of interest rate cut/forward guidance Interaction with QE (current MoPo affects future MoPo and )
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Motivation
Interest rate cut Substitution effect: safe asset risky loans
Wealth effect: negative rate = tax Not in representative agent analysis
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Motivation
Interest rate cut Substitution effect: safe asset risky loans
Wealth effect: negative rate = tax
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Banks balance sheet
policy rate
predetermined
, depends on competition & elasticities
depends on investors
Equity
Deposits @
A L
Reserves @
0
Bonds @
Loans @
WholeSale@
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Model
Loan market (aggregate) semi-elasticities
= 01 log
Deposit market (aggregate)
= 01 | log
|
= argmax (, , ) Bank competition
banks
Bertrand competition
but house bank advantage Liquidity service
Cash is imperfect substitute
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Model
Loan market (aggregate) semi-elasticities
= 01 log
Deposit market (aggregate)
= 01 | log
|
= argmax (, , )
Example:
= 1 (Cobb-Douglas)
= 1 + 1 (1)
(CES, elasticity of subst.) for = perfect substitutes ZLB
for = 0 perfect complements Bank
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Model
Loan market (aggregate) semi-elasticities
= 01 log
Deposit market (aggregate)
= 01 | log
|
= argmax (, , )
Example:
= 1
= 1 + 1 (1)
For varying
Bank
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Model
Loan market (aggregate) semi-elasticities
= 01 log
Deposit market (aggregate)
= 01 | log
|
= argmax (, , )
Bank competition banks
Bertrand competition
but house bank advantage
Liquidity service
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Model
Loan market (aggregate) semi-elasticities
= 01 log
Deposit market (aggregate)
= 01 | log
|
= argmax (, , ) ,
log ;
Bank competition banks
Bertrand competition
but house bank advantage
Liquidity service
+
Mark-up
Mark-down
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Roadmap
1 period model Impact of rate cut on profit/equity
Competition structure unconstrained
Interaction with financial regulation constrained
Impact of rate cut on lending
Determinants of Reversal Ratesemi-elasticities
Multi-period model Maturity structure of legacy holdings vs. NIM-business
Optimal length of interest cut
Optimal dividends for lending
Interaction with QE optimal sequencing
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Roadmap
1 period model Impact or rate cat on profit/equity
Perfect competition perfect pass through
Local monopolist/monopsonist imperfect pass throughmark-up depends on semi-elasticities
1 =max,
+ ()
+
+(1 + )0
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Perfect competition pass through
= = perfect pass through
1. Profit from NIM-business, = 0
2. Zero pass through on , d = Funding of bonds that yield is now lower by
Interest rate cut = stealth recapitalization
Equity
Deposits @
A L
Reserves @
0
Bonds @
Loans @
WholeSale@
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Monopoly
Loan problem is separate from deposit problem Why? Reserve holdings is in between
Loan rate after mark-up
= + (), 1()
Deposit rate after mark-down
= + (), 1()
Next period equity has four parts:
1 = + + + (1 + )0
Implicit assumption: Price stickiness
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Response to interest rate change
Monopoly/monopsony1 =
+
1
+ + (1 + )0
1
=
By envelop theorem, NIM are changed
by cost of funding (deposit minus loans) are changed
Prop. 1:
1
=
Net interest margin+ 0
rolledover equity
reevaluation
=
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Constraint
Economic or regulatory constraint
0 10
1
0
Decline in equity decline in lending
If constraint binds: interest rate cut cant lead to a substitution from to
Loan mark-up even larger than in monopoly case
Deposit margin is not affected Since constraint only binds Loan and deposit decisions are separable
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Impact on LENDING
Constraint 0
1
0
10
= 1
1
1
Sum up: Interest rate cut can lead to more or less lending
(depending how large is)
Need data on banks interest rate sensitivity (Sraer et al. 2015, Piazzesi et al. 2015)
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Reversal Rate determinants
Prop 2: For sufficiently large 0,1, there exists a reversal rate
such that an interest rate cut beyond
is contractionary (reduces lending)
is generically not zero
Prop 3,4,5: (comparative statics) decreases in , increases in 0 and 1 weakly decreases in and weakly increases in
weakly decreases in and weakly increases in
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Numerical example: 1 period model
Constant & , = = , for different
Policy ratePolicy rate Policy rate
Policy rate
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Restriction on dividend policy
Prop 9:Banks dividend policy does not optimize lending after an interest rate cut.
Idea Interest rate cut can recapitalize banks
Part of the capital gains is wasted due to dividend payouts
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Multi-period model (sketch)
Maturity of legacy assets = 3 periods
Interest rate cut is expected to last for 5 periods
Cash flow
If interest rate is expected to last too long it counterproductive
Ideal length of interest rate cate maturity of
Present Value impact on equity valuation
=1
31
1 + + +
>0
+
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Multi-period model (sketch)
Maturity of legacy assets = 3 periods
Interest rate cut is expected to last for 5 periods
Cash flow
If interest rate is expected to last too long it counterproductive
Prop 7: Ideal length of interest rate cut maturity of
Prop 8: Increase in bond duration implies increase in duration of lending-maximizing
policy rates
Present Value
Cash flow = = = = =
Legacy asset
(+)
(+)
(+)
NIM-business
()
()
()
()
()
in I theory =
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RR & forward guidance
Forward guidance = duration of interest rate cut shrinks over time
Effect of the interest rate cut dies out and -effect dominates
Length of forward guidance should depend on maturity of positions
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RR & QE: Optimal sequencing
1. Induce banks to hold more long-run assets
2. Interest rate cut stealth recapitalization
3. QE: banks sell now highly priced long-run assets to CB
4. Further interest rate cut is less effective/contractionary
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RR & QE: Optimal sequencing
1. Induce banks to hold more long-run assets
2. Interest rate cut stealth recapitalization
3. QE: banks sell now highly priced long-run assets to CB
4. Further interest rate cut is less effective/contractionary
Reloading strategy
1. if banks suffer losses (e.g. delinquencies) & RR rises >
2. Raise policy rate (to increase banks interest margin)
3. Reverse QE or another LTRO
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Heterogeneity
Across banks Banks with large legacy assets benefit
Banks with low equity and large NIM-business (going forward) suffer
Across countries (pass through) whole sale funding in Sweden
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GE perspective: credit demand perspective
So far, Strong focus on banks & credit supply
Redistribute wealth towards banks to stimulate credit supply
Low pass through of lending rate/deposit rate affects redistribution credit demand aspects Households benefit less from smaller reduction in
suffer less from smaller reduction in High MPC or low MPC households
Firms Balance sheet constrained or not
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Literature
Theory Oligopoly: Business margin: Monti-Klein model ( = 0)
Competitive: Re-evaluation: BruSan I theory of money
Interest rate sensitivity of banks Stock price: Flannery & James (1984), Begenau et al. (2015)
Lending: Landier et al. (2015)
Deposits: Drechsler et al. (2015),
Deposit rate pass through Competition: Maudos & de Guevarra(2005)
Delay: DeBondt (2005)
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Conclusion
Zero/negative interest rates are not special!
Interest rate cut Substitution effect: safe asset risky loans
Wealth effect: tax + prudential regulation
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Conclusion: Reversal Interest Rate
Zero/negative interest rates are not special!
Interest rate cut Substitution effect: safe asset risky loans Wealth effect: tax
+ prudential regulation Reverses substitution effect + amplification
What determines the Reversal Rate? Market structure and pass through of rates Interaction with prudential regulation Banks equity capitalization countercyclical regulation Duration risk of banks (long-dated assets) Length of rate cut (forward guidance) & maturity legacy assets Timing of dividends Interaction with QE (correct sequencing)
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Conclusion: Reversal Interest Rate
Zero/negative interest rates are not special!
Interest rate cut Substitution effect: safe asset risky loans Wealth effect: tax
+ prudential regulation Reverses substitution effect + amplification
What determines the Reversal Rate? Market structure and pass through of rates Interaction with prudential regulation Banks equity capitalization countercyclical regulation Duration risk of banks (long-dated assets) Length of rate cut (forward guidance) & maturity legacy assets Timing of dividends Interaction with QE (correct sequencing)
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Safe Assets & Valentin Haddad
Princeton University
Federal Reserve Board Washington, Aug. 2nd, 2016
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Definitions of Safe Asset
1. Safe = risk-free for a particular horizon E.g. holders are infinitely risk aversion Caballero & Farhi but inflation risk
2. Safe = informationally insensitive No decline in value due to asymmetric info
3. Safe = Good friend analogy Safe for random horizon Appreciates in times of crisis
Safe = Safe Asset Tautology Safe because perceived to be safe
(multiple equilibria)
Bubble
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Definitions of Safe Asset
1. Safe = risk-free for a particular horizon E.g. holders are infinitely risk aversion Caballero & Farhi but inflation risk
2. Safe = informationally insensitive No decline in value due to asymmetric info
3. Safe = Good friend analogy Safe for random horizon Appreciates in times of crisis
Safe = Safe Asset Tautology Safe because perceived to be safe
(multiple equilibria)
Bubble
Holmstrom& Gordon
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Definitions of Safe Asset
1. Safe = risk-free for a particular horizon E.g. holders are infinitely risk aversion Caballero & Farhi but inflation risk
2. Safe = informationally insensitive No decline in value due to asymmetric info
3. Safe = Good friend analogy Safe for random horizon Appreciates in times of crisis
Safe = Safe Asset Tautology Safe because perceived to be safe
(multiple equilibria)
Bubble
Brunnermeier & Haddad
Holmstrom& Gordon
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Safe asset & money - close cousins
Store of value store of value
Held in addition to risky assets
Held in order to produce (private) safe assets (by banks!)
Reference/benchmark asset unit of account
Good collateral: stable margins transaction role Facilitates financial trade
Pool ofrisky high yield assets
Safe asset Deposits
Equity
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Safety versus Risk
US Treasury downgraded by S&P (due to default risk) but yield declines
German CDS spread versus yield during Euro crisis
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Model ingredients
Risky investment is subject to liquidity shocks A la Holmstrom & Tirole 1998
Liquidity shocks can be dealt with Safe assets
Market liquidity (or risky asset)
Market liquidity is endogenous To economic activity
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The Curse of Safety
Investment equilibrium
High real investment
High market liquidity of risky assets Less safe asset holdings
necessary
Pool ofrisky high yield assets
Safe asset
Equity Risky assets
Safe asset
Equity
Safety equilibrium
Low real investment
Low market liquidity of risky assets High safe asset holdings
necessary
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Model setup
Continuum of investors Take prices and market liquidity as given
Maximize final wealth max[]
Three periods = 0: Allocate initial resources to risky and safe asset
= +
= 1: Liquidity shocks
= 2: Output is realized
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Opportunity set
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Dealing with liquidity shock
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Dealing with liquidity shock
Remarks: Liquidity demand: marginal return from safe assets is larger
when insufficient cover for liquidity shock Market liquidity is only relevant when used
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Individual demand for safety
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Individual demand for safety
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Role of market liquidity (of risky asset)
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Equilibrium
Aggregate supply of safe asset Elastic supply fixed
Aggregate market liquidity Risky investment fosters liquidity > 0
Better substitutability in secondary market Micro-foundation: Search market externality (see paper)
cv
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Aggregate demand for safety
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Aggregate demand for safety
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Equilibria
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The Curse of Safety Investment equilibrium
High real investment
High market liquidity of risky assets Less safe asset holdings
necessary
Riskyassets
Equity Risky assets
Safe asset
Equity
Safety equilibrium
Low real investment
Low market liquidity of risky assets High safe asset holdings
necessary
Private demand for safety crowds out market safety Invest in safe asset rather than risky -> low market liquidity
-> more need for safe assets
cvc
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Conclusion The Curse of Safety
Scarcity of safe asset because in wrong equilibrium Secular stagnation
(too little risky real investment)
Fight fire with fire Reduce supply of safe asset
(in order to jump to good equilibrium)
In international context: Capital controls