Sometimes it seems like macroeconomics never makes any progress. Fads go in an out of style in an endless cycle: classical, Keynesian, classical, Keynesian, classical, Keynesian, etc. Beneath the surface, however, progress is steadily occurring. Today provided one more example.
A few years ago there was a lively debate as to whether negative interest on reserves would be expansionary or contractionary. Pundits who took a “finance approach” suggested the effects would likely be contractionary, due to their impact on the financial markets. Market monetarists argued that policies that pay less interest on base money are expansionary, because they reduce the demand for base money. Today provides another powerful example that the monetary approach to macro is superior to the finance approach, as the yen plunged on news that the BOJ had unexpectedly adopted negative IOR (after dismissing the idea just weeks ago.) There had been previous experiments in Europe with the same outcome, but some of them were combined with QE. This was a particularly clean test, in a major economy:
Bank of Japan Governor Haruhiko Kuroda sprung another surprise on investors Friday, adopting a negative interest-rate strategy to spur banks to lend in the face of a weakening economy.
The move to penalize a portion of banks’ reserves complements the BOJ’s record asset-purchase program, including 80 trillion yen ($666 billion) a year in government-bond purchases, which was kept unchanged at the board meeting. By a 5-4 vote, Kuroda led his colleagues to introduce a rate of minus 0.1 percent on certain excess holdings of cash.
Long a pioneer in adopting unorthodox policies to tackle deflation and revive economic growth, the BOJ is now taking a page out of European policy makers’ playbooks in the goal of stoking inflation. The yen tumbled after the announcement, which came after Kuroda just last week rejected the idea of negative rates.
It will be interesting to see if those claiming negative IOR would be contractionary will now admit their error.
PS. Here’s a FTAlphaville post by Izabella Kaminska from 2012:
If imposed, negative rates would be enforced via the base money market. This could see banks charged for holding excess reserves at the central bank. Which ever way you look at it, the move would ultimately be contractionary rather than expansionary because it would lead to base money destruction, or wider credit destruction as banks hand over credit to cover charges.
HT: Cameron, Julius Probst