Global Safe Yields Continue Their Downward March

So yields on Germany's 10-year government bonds have gone negative. Put differently, investors are now paying the German government to take and hold their funds for ten years!  Many are blaming this development on Brexit fears and the ECB's bond buying program. While this is a reasonable proximate explanation, the recent decline is part of a far bigger story: interest rates on safe assets across the world have been declining since 2008. This can be seen in the figure below.


This downward march of safe yields is a consequence of the safe asset shortage problem. What we are seeing in Germany is just the latest manifestation of it. What the above figure should make clear is that this safe asset shortage problem has been going on outside of QE programs and before central banks started doing negative interest rates. So don't blame central banks for the low interest rates.1

This downward march of safe yields across the globe is a big deal. It indicates the global economy needs more safe assets and lower interest rates to clear. However, at some point, the effective lower bound (ELB) will kick in and prevent rates from going lower. When that happens something else will have to adjust--output--and there will be a global race to the ELB. Here is Caballero, Fahri, and Gourinchas (2016) making this point:
In the open economy, the scarcity of safe assets spreads from one country to the other via the capital account. Net safe asset producers export these assets to net safe asset absorbers until interest rates are equalized across countries. As the global scarcity of safe assets intensifies, interest rates drop and capital flows increase to restore equilibrium in global and local safe asset markets. Once the ZLB is reached, output becomes the adjustment variable again. 
In other words, be ready for more! If you think pension funds, banks, insurance companies are scrambling for yield now, you ain't seen nothing yet! More importantly, the Cabellero, Fahri, and Gourinchas analysis suggest a global growth slowdown is likely too. 

So what are the solutions to the safe asset shortage problem? I will refer you again to the figure I used in my last safe asset post for the answers. My preferred solution is to try the 'shock and awe' approach to improve the economic outlook via a NGDP level target backstopped by Treasury. 


Related Link:
US as a Banker to the World

1Though one can blame central banks for allowing us to get in this position in the first place. As I have argued elsewhere, the Fed and ECB could have done more to avoid the Great Recession. The did not and now the safe asset problem horse is out of the barn.

Comments

Post a Comment

Popular posts from this blog

Storytelling: Friday Chart Edition

Image
I have not posted here in awhile, so I thought it would be good to share a few recent charts that tell interesting stories. Central Bank Balance Sheets First up, are two charts that show the relationship between the size of the central bank balance sheets and inflation rates. The first one shows for the 2010-2019 period the average size of central bank balance sheets as a percent of NGDP plotted against the average core inflation rate. Since larger balance sheets are typically seen as adding more stimulus to the economy, one might expect to see a positive relationship between their size and the inflation rate over this long of an horizon. Instead, we see a negative relationship: One objection to the above chart is it may be misleading since it is the rate of change in central bank liabilities, not the level, that should drive the inflation rate. To that end, the next chart shows the change in the size of the central bank balance sheets over the same period. The same relationship ho...
Read more

The Passive Tightening of ECB Policy

I recently argued that the Fed and the ECB were passively tightening monetary policy and thus responsible, in part, for the increasing economic stress in their regions.  Michael T. Darda makes the same argument today for the Eurozone in his note titled " Anatomy of a Deflationary Debt Collapse ": As the ECB fiddles with its forecast, European inflation-indexed bond spreads have plunged to record lows, while eurozone corporate bond spreads continue to hit new highs for the year. Inflation breakeven spreads in the indexed swap market in Europe have tumbled to the lowest level on record (i.e., below both the 2008 and 2010 lows). With corporate bond spreads at new 2011 highs this morning, the European Central Bank can now be blamed for a passive tightening of monetary policy. Why? Central banks are responsible for responding to velocity shocks by adjusting the supply of money to offset changes in the demand for money. If there is a spike in the demand for money and a central...
Read more

A Note to FOMC Members

According to this Bloomberg article , you are seriously discussing the adoption of an explicit inflation target.  Let me remind you that a price level target is even better since it has "memory".  Let me also remind you that during the September, 2010 FOMC meeting you folks discussed the possibility of a nominal GDP level target. There is much to like about a nominal GDP level target --it improves upon a price level target in how it handles supply shocks--and I hope you seriously consider it too.  
Read more