December 25, 2016


Are Negative Rates Backfiring? Here's Some Early Evidence (GEORGI KANTCHEV,  CHRISTOPHER WHITTALL and  MIHO INADA,  Aug. 8, 2016, WSJ)

Recent economic data show consumers are saving more in Germany and Japan, and in Denmark, Switzerland and Sweden, three non-eurozone countries with negative rates, savings are at their highest since 1995, the year the Organization for Economic Cooperation and Development started collecting data on those countries. Companies in Europe, the Middle East, Africa and Japan also are holding on to more cash.

Economists point to a variety of other possible factors confounding central-bank policy: Low inflation has left consumers with more money to sock away; aging populations are naturally more inclined to save; central banks themselves may have failed to properly explain their actions.

But there is a growing suspicion that part of problem may be negative rates themselves. Some economists and bankers contend that negative rates communicate fear over the growth outlook and the central bank's ability to manage it.

Negative rates reflect the banks' realization that deflation is a long-term phenomenon, so even if you put your money in a mattress it will be worth more when you spend it.  Invest it and your returns are staggering.

The Destructive Power of Inflation (Martin Feldstein, 12/22/16, Project Syndicate)

[I] remember being in Argentina in the mid-1990s, when there was virtually no inflation. Back then, the Argentine peso was pegged to the US dollar, and both currencies were used equally for day-to-day transactions on the streets of Buenos Aires.

But the subsequent collapse of the peso's dollar peg, and the forced conversion of dollar contracts into peso contracts at a non-market exchange rate, caused inflation to soar. By 2003, the annual rate had increased to 40%. It then fell to 10% for a few years. But it rose again during the presidencies of Néstor Kirchner and his wife and successor, Cristina Fernández de Kirchner, to 25%. It finally jumped back up to 40% in 2016, propelled by the removal of distortionary price subsidies that had previously been used to disguise the true inflation rate.

The recent high rates of inflation, and the public's memory of even higher rates in the past, have severely harmed Argentina's economy.

Because market interest rates rise to compensate for high inflation, even the government must now pay an interest rate of about 25% to borrow in pesos for short periods. Lenders are unwilling to provide long-term credit at fixed interest rates, because a jump in inflation would destroy the value of their bonds and loans.

Households and businesses are reluctant to finance long-term investments with short-term loans or with variable-interest-rate loans, because a jump in inflation would cause their interest payments to rise sharply. Indeed, Argentina's history of high and variable inflation has destroyed the domestic mortgage market, making it impossible for a household to use a mortgage to buy a home. Businesses are also reluctant to borrow, because they recall how previous increases in inflation - and thus in interest rates - pushed otherwise healthy companies into bankruptcy.

The life insurance industry has been destroyed by high and uncertain inflation as well. Given that no one knows what the peso will be worth when future claims are paid, why would anyone buy insurance with today's pesos?

Economists might respond by suggesting that mortgages, insurance contracts, and other agreements could be indexed to the price level, adjusting payments to the contemporary rate of inflation. But when the inflation rate is changing rapidly, it is hard to know what the contemporary rate even is.

Posted by at December 25, 2016 9:11 AM


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