#lowerbound

"After years of falling prices and fitful growth, Japan’s nominal GDP was roughly the same in 2015 as it was 20 years earlier. America’s grew by 134% in the same time period; even Italy’s went up by two-thirds. [..] The lesson many are quick to draw from Abenomics is that the weapons deployed by the Bank of Japan (BoJ)—and, by extension, other central banks—since the financial crisis do not work. The BoJ has more than doubled the size of its balance-sheet since April 2013 and imposed a sub-zero interest rate in February;[..] The naysayers have it wrong. Unlike other countries, Japan includes energy prices in its core inflation figure. Excluding them, core consumer prices have risen, albeit modestly, for 32 months in a row. Before Abenomics, Japan’s prices had fallen with few interruptions for over ten years; they are now about 5% higher than they would have been had that trend continued. Japan has increased inflation while it has fallen in Australia, Britain, France, Germany, Italy and Spain. If central banks have more sway than some pundits allow, Abenomics also shows the limits of their power. The BoJ has buoyed financial assets, but it has failed to drum up a similar eagerness on the part of consumers or companies to buy real assets or consumer goods. Household deposits are high. [..] [firms have been] less eager to lift investment or base pay (which are harder to reverse). Japan’s non-financial firms now hold more than ¥1 quadrillion ($9.5 trillion) of financial assets, including cash. Herein lies another lesson of Abenomics: monetary policy is less powerful when corporate governance is lax and competition muted. [..] if Japan’s equity culture were more assertive still, shareholders might demand more of the corporate cash hoard back—to spend or invest elsewhere. And if barriers to entry were lower, rival firms might expand into newly profitable industries and compete away these riches. They might also pay more. In theory, reflating an economy should be relatively popular, because wage rises should precede price increases. In reality, the price rises came first and pay has lagged behind. That is why the IMF has pushed for Japan to adopt an incomes policy that spurs firms to raise wages. [..] Abenomics has not only demonstrated how self-defeating fiscal austerity can be, particularly when it comes in the form of a tax on all consumers. It has also shown that, in Japanese conditions, sustained fiscal expansion is affordable. Without any private borrowers to crowd out, even a government as indebted as Japan’s will find it cheap to borrow. Japan’s net interest payments, as a share of GDP, are still the lowest in the G7. [..] greater boldness is needed—to encourage more foreign workers into the country, for example, and to enable firms to hire and fire more easily. But a revival in demand has encouraged supply-side improvement, not simply substituted for it. Stronger demand for labour has drawn more people into the workforce, despite the decline in Japan’s working-age population. [..] Abenomics has fallen short of its targets and its overblown rhetoric. That makes it easy to dismiss as a failure. In fact, it has shown that central banks and governments do have the capacity to stir a torpid economy. And in some senses, the hype was needed. Japan’s stagnation had become a self-fulfilling prophecy"

"Interest rates are the oil in the financial system’s engine, helping capital to flow from one area to another. There is a reason that rates have been positive for the past three centuries, despite world wars and the Depression. The system isn’t designed for a world of ultra-low, let alone negative, rates. The traditional business of banking is to take money from depositors (a bank’s liabilities) and lend it, at higher rates and over longer periods, to borrowers (its assets). So an important driver of profits is the shape of the “yield curve”—the chart of interest rates for different durations. The smaller the gap between short- and long-term rates (the flatter the yield curve, in the jargon), the harder it is for banks to make money. The problems become even greater as bond yields near zero. Banks face resistance from depositors if they try to charge them for the privilege of having money in an account. Even as the return on banks’ assets declines, it is hard for them to reduce the cost of their liabilities. When a central bank imposes negative interest rates on the reserves commercial banks keep with it, as those in Europe and Japan have done, it is thus very hard for the banks to pass this cost to depositors. Negative rates act as a tax on bank profits. [..] there is another factor at work. Many commercial banks own portfolios of government bonds, in part because regulators require them to keep a stock of liquid assets on hand. The interest payments on those bonds used to be a handy source of income. But as older, higher-yielding bonds mature, they are being replaced with much lower-yielding assets. Mr Napier estimates that this factor alone will cut European bank profits by 20% over several years. Offsetting this effect will be hard. Either costs will have to be cut by 10% or banks will have to charge their borrowers an extra 0.3% a year. But pulling off the latter trick would not be economically helpful; central bankers are trying to reduce, not increase, the cost of corporate borrowing. Banks are not the only institutions to be affected. Insurance companies used to follow the Warren Buffett model for making money: collect the premiums upfront, invest them wisely, and use the returns to create a cushion against bad news on the underwriting front. These days, thanks to regulations, insurers have very little exposure to risky assets like equities. They buy bonds to match their assets with their liabilities. But insurance companies in Germany and Switzerland are stuck with savings products they sold in happier times, which guaranteed returns well above current yields. A similar problem hit Japanese insurers in the 1990s and 2000s. Insurance companies that have asset-management arms have some protection from this pressure. The savings products they sell are not guaranteed, instead offering returns linked to the financial markets. But the impact of low returns is slowly squeezing asset managers too: clients tend to notice the impact of fees much more than they did when returns were in double digits. New business is gravitating towards low-cost exchange-traded funds and index-trackers. A similar problem afflicts private banks, whose wealthy clients are starting to wake up to the impact of fees. In a way, each sector’s problem is a manifestation of the same phenomenon. Short-term interest rates and government-bond yields are the risk-free rates that form the basis of all financial returns. The expected return on equities comprises the risk-free rate plus a premium to allow for the volatility of the stockmarket and the risk of capital loss. A good chunk of the income of financial-services companies is the “cut” they take out of these returns. Now there is simply less return to share around."

" Late last year the yield on 10-year U.S. government bonds was around 2.3 percent, already historically low; on Friday it was just 1.36 percent. German bonds, the safe asset of the eurozone, are yielding minus — that’s right, minus — 0.19 percent. [..] In some past episodes of very low government borrowing costs, the story has been one of a flight to safety: investors piling into U.S. or German bonds because they’re afraid to buy riskier assets. But there’s little sign of such a fear-driven process now. The premiums on risky corporate bonds, which soared during the 2008 financial crisis, have stayed fairly low. European bond spreads, like the difference between Italian and German interest rates, have also stayed low. And stock prices have been hitting new highs. [..] A number of economists — most famously Larry Summers, but also yours truly and others — have been warning for a while that the whole world may be turning Japanese. That is, it looks as if weak demand and a bias toward deflation are enduring problems. Until recently, however, investors acted as if they still expected a return to what we used to consider normal conditions. Now they’ve thrown in the towel, in effect conceding that persistent weakness is the new normal. This means low short-term interest rates for a very long time, and low long-term rates right away. Many people don’t like what’s happening, but raising rates in the face of weak economies would be an act of folly that might well push us back into recession. What policy makers should be doing, instead, is accepting the markets’ offer of incredibly cheap financing. Investors are willing to pay the German government to take their money; the U.S. situation is less extreme, but even here interest rates adjusted for inflation are negative. Meanwhile, there are huge unmet demands for public investment on both sides of the Atlantic. America’s aging infrastructure is legendary, but not unique: years of austerity have left German roads and railways in worse shape than most people realize. So why not borrow money at these low, low rates and do some much-needed repair and renovation? This would be eminently worth doing even if it wouldn’t also create jobs, but it would do that too."