Bond yields and helicopters

The ever-optimistic OBR has some encouraging forecasts for interest rates and global government bond yields:

Well, ok, they were rather more encouraging in November than they are now. The uplift was supposed to start ANY DAY NOW, but there has been an interruption to normal service. Leaves on the line, perhaps. Or the wrong sort of snow.

The trouble is, the OBR has a long record of hockey-stick forecasting. Not that it is unique in having a noticeable bias to the upside:

If ever there were evidence that economic forecasting owes more to magic than science, it is this pair of charts. Markets expected that interest rates would start rising in 2010, 2011, 2012, 2013, is now 2016 and markets are beginning to wonder if they will ever rise. There is a feeble uplift pencilled in for 2018, and the ghost of a suggestion that there could even be a rate cut this year. The runes have failed, not once but repeatedly. Sack the shamans.

Why the runes have failed is not at all clear. The UK's disastrous productivity record and the ongoing weakness in policy rates (and by extension, bond yields) appear correlated, but that does not mean that one causes the other - indeed as productivity is a residual, it seems unlikely that it has any causative effect. Rather, I think both should be seen as responding to an underlying problem. But what is the problem?

Over at Morgan Stanley, Matthew Hornbach has an idea what might be going on. He's talking about the US, but of course persistent downwards adjustment to interest rate, bond yield and output forecasts is not purely a UK phenomenon: the entire Western world is suffering from limp outturns. In a research note (h/t Jamie McGeever of Reuters), Hornbach speaks about his Japanese experience, and how it relates to Morgan Stanley's forecasts for US bond yields:
We see 10-year Treasury yields ending 2016 at 1.75%, near current levels. But we see even lower yields catching investors off guard in the middle quarters of the year. The lessons I learned in Japan leave me comfortable with this outlook. Years of staring at low JGB yields certainly immunized me from the sticker shock associated with low Treasury yields. And I know that investors tried to short JGBs mostly without success for years. 
If Hornbach is right, the "widowmaker" is no longer solely Japanese. Shorting the bonds of any Western country with an activist central bank and a poor economic outlook is a mug's game. The OBR's forecasts for global bond yields are, once again, over-optimistic. There is little reason to assume that the downwards trend of bond yields will reverse any time soon, and considerable reason to think that yields will go substantially more negative.

Hornbach has, of course, been reading Koo. Not everyone agrees with Koo's prescription for solving Japanese-style stagnation: but there is now broad agreement about his diagnosis. With few exceptions, the Western world is in a balance sheet recession, in which demand for credit becomes inelastic with regard to price. Even deeply negative rates don't significantly increase credit demand.

Negative rate aficionados find this incomprehensible. Why wouldn't people borrow if they were paid to do so? But when balance sheets are highly leveraged, people will not take on more debt EVEN IF interest rates turn negative, because they believe that interest rates will eventually rise and they will then have problems refinancing the debt at affordable rates. Deeply negative rates as a temporary shock to kickstart credit demand founder on the rock of Ricardian equivalence. (Miles Kimball, this is my response to your question!)

This enables us to identify what the "underlying problem" is. The desire of the private sector to avoid taking on debt at any price is a significant squeeze on aggregate demand, which reveals itself as stubbornly low inflation and poor growth. It inevitably puts downwards pressure on sovereign bond yields:
As our economists have suggested before, the world is dealing with demand deficiency. The decline in government bond yields globally suggests simply that the deficiency is growing. 
So what to do about this? Well, spend some money, really:
If the private sector is not willing or able to borrow and spend enough to generate a sustainable inflation impulse, despite the increasingly lower costs to do so, then the public sector should step in to prevent deflation.
Ultimately, that is the message from government bond markets today. The public sector, to the extent it can control its own money supply, needs to borrow and spend because the private sector is not spending enough. The situation has gotten so extreme that investors are willing to pay certain governments to do just that. In Japan, with a negative yield on 10-year JGBs, investors are paying the government to borrow out to a 10-year term and spend. If the public sector ignores these types of messages on a global scale and private demand globally remains deficient, those same investors will accept still lower yields on government bonds outside of Japan – our base case for the rest of 2016.
Whether this "borrowing and spending" takes the form of fiscal stimulus or central bank intervention is irrelevant. Somehow, more money has to get into the economy.

Maybe it is time we stopped our ears to the siren voices that lure us on to the rocks of economic stagnation by singing about the virtues of fiscal consolidation, and started listening to the song of the bond markets. Bond vigilantes are chimeras: the bond markets want more of the debt of Western countries with activist central banks, not less.

Fiscal consolidation is the wrong medicine in a balance sheet recession. It removes from the economy money needed by the private sector to repair balance sheets: central bank monetary stimulus is weakened by fiscal consolidation, because the government siphons the water out of the tub nearly as fast as the central bank puts it in. And monetary stimulus which primarily benefits the rich, such as QE, is inadequate anyway. As Nouriel Roubini says, money needs to get into the hands of people who will spend it, not save it:
Second, QE could evolve into “helicopter drop” of money or direct monetary financing by central banks of larger fiscal deficits. Indeed, the recent market buzz has been about the benefits of permanent monetization of public deficits and debt. Moreover, while QE has benefited holders of financial assets by boosting the prices of stocks, bonds, and real estate, it has also fueled rising inequality. A helicopter drop (through tax cuts or transfers financed by newly printed money) would put money directly into the hands of households, boosting consumption.
Break out those helicopters.

Related reading:

All QE is "people's QE", just not the right people - The Exchange, FT
Rethinking government debt
Helicopters are easy to fly - Simon Wren-Lewis


  1. Five Tweets About the #PanamaPapers

  2. Why do you think there is no difference between fiscal policy and QE? When it is quite clear that fiscal policy increases incomes and QE does not (just an asset swap)?

    "Whether this "borrowing and spending" takes the form of fiscal stimulus or central bank intervention is irrelevant. Somehow, more money has to get into the economy."

    QE does get more money into the economy if your definition of money excludes TSY Cds. which confuses many people since they dont understand why "printing money" by the trillions doesnt actually do anything for the economy. Of course if you correctly include TSY CDs in your definition of the money supply j(ust like everyone includes commercial bank term accounts) then it becomes obvious that QE isnt printing money at all since all it does is swap one type of public bank account (TSY cds) with another (reserves).

    1. I have not equated fiscal policy with QE. I clearly stated that QE was monetary stimulus, and inadequate because of its distributional effects. "Central bank intervention" does not necessarily mean QE. The Bank of England's FLS scheme, for example, is not QE.

      I am not here going to discuss the nature of QE and whether or not Treasury bills should be regarded as money. I have discussed that many times before, and as this post is not about QE anyway, I see no reason to discuss it again here.

      I regard the distinction you draw between fiscal and monetary policy as entirely spurious. Helicopter money, which is what I am advocating here, is to all intents and purposes money-financed deficit spending.

    2. QE is "fiscal" because it "taxes" the economy by removing interest income from the private to public sector.

  3. I have been wondering how would it be realistic to predict a rise in interest rates? As far as I know the economies of almost all countries are more indebted relative to GDP than ever before. In my layman's logic (higher debt to gdp means economy can only survive lower real interest rates than low debt to gdp) without inflation it will be "impossible" to raise interest rates without sinking the economy.

  4. Great post as always.

    I'm struggling to understand the kind of politics which prevents deficit spending at a time when there is almost a universal consensus from economists for it. I've seen calls from the IMF, the Economist and FT for deficit spending, these are hardly bleeding heart liberals.

    In the Eurozone I know Germany is a problem. But what about the UK and USA? What's stopping them?

    1. But isn't politics also the reason why helicopter money would never be implemented in the UK - it just destroys the Tory/New Labour narrative that "there is no money".

    2. Imho the risk with money-financed deficit-spending is that it's going to leak outside the country's borders, i.e. it's going to be spent on imports and stimulate production abroad. Frances explained in her balance-of-payments article how that might have negative results, so effectively we're at an impasse.

  5. Are lack of demand and low productivity related ?- in my early working days piecework was favourite abdication of management ie pay directly related to output. Has zero hour contracts removed efficiency/output incentives along with low pay / benefits top up negating automation?

    1. No doubt there is some relationship between deficient demand and low productivity, but it's quite possibly circular. Low productivity results in poor wage growth which forces households to limit spending, resulting in deficient demand which discourages business investment thus depressing productivity....

      I doubt if zero hour contracts are a major cause of low productivity. From a business perspective, they actually improve efficiency. There does seem to be some evidence that companies substitute low-paid labour for investment in technology, thus depressing productivity.

  6. Does helicopter money have to be time limited ie spend it or it decays?

    1. It could be. That would prevent it being saved. There is renewed interest in Gesell money as a way of discouraging hoarding. Of course, you would also have to find a way of preventing it being used to buy unproductive assets such as gold.

  7. All budget deficits are already helicopter money.

    There's no difference between government spending and then offering bonds than just plain old government spending. In an accounting sense.

    The paper by Kelton and Fullwiler prove this point.

    1. This is exactly the point I was making.

    2. Yes you were. I wasn't having a go at you. Just adding my tuppence worth.

      I like your posts very informative.

  8. I think that for practical purposes, helo money has to be defined as money injected *past* the financial parts of the economy into the real economy.

    I think the essential issue is that rentiers are unreasonable about allowing normal people any power, political or economic, even when that means squashing the basis for future profits. They have every intention of maintaining relative positioning, even if that means an overall decline in wellbeing. Willfully paying wages so low that it creates turnover no matter how desperate job seekers are, even though any financial gains are eaten up by labor acquisition and training... Costo, Trader Joe's, and Southwest Airlines are all corporations that do things in a more sane, profitable manner--and they are still outliers. There is definitely a cultural element to things.

    There is one very quick way that the US can improve productivity--repeal the 2005 bankruptcy law. Normal people can use the increase in power to do more useful things. Said useful things will need new people and equipment, and virtuous cycle starts...

  9. Uk lack of productivity policy is a deliberate act.
    It is no accident.
    Again we must simply look at official Uk energy data.
    Wood into electricity conversion was approaching half of steam coal / elec burn in the fourth quarter.
    This is a full employment (social control) policy.

    These are unprecedented energy figures.
    Never before has a country engaged a industrial sabotage policy on this scale.
    Refer to March Uk energy trends publication covering all of 2015.

  10. The history of the UK and unfortunately it's export of scarcity ideals to the rest of the world is essentially about the introduction of fossil fuels into former peasant lifestyles.
    For 300 years these serfs ran around in circles at ever increasing speeds.
    This race is otherwise known as productivity growth.
    Now that the surpluses created have become too difficult to manage the authorities wish to reintroduce a form of pre industrial capitalism.
    That is the previous replacement of the farm and commons with the ranch and all its waste.( including massive deforestation of marginal land)

    Its unfortunately all very predictable.

  11. Uk sub regional electricity consumption figures is telling.
    %change 2005 (peak) -2014
    London (highest): -0.1%
    North east (lowest): -17%

    All in favour of local authorities shutting down or shielding streetlights in the early morning hours but the decline is one of domestic consumption me thinks.
    The North East has the lowest mean and median domestic consumption
    3,418 kwh & 2,901 kwh respectively.

    South east
    4,294kwh & 3,418 kwh respectively....

    Puts the Energy Trends "cold and warm winter explanations in perspective.

    The North east is the coldest part of England in the spring as the wind blows over the North Sea.

    We are in reality witnessing extreme poverty as a result of massive rentier flows toward financial centers.
    Totally unbalancing rational production /
    consumption dynamics.

  12. An excellent set of graphs. With the outcomes demonstrated, you would have thought that a scientific approach might be to start questioning the model being used ...

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  15. With bond yields so low, company pension plans must consume more capital to guarantee their solvency. It becomes very expensive for companies to justify hiring new workers, as so much capital now needs to be reserved in pensions. People are living longer than ever. Low interest rate expectations mean a higher proportion of salaries must be saved. Huge numbers of future retirees soon coming to claim benefits means pensions often need a higher proportion of safer assets. The demand for safe assets has driven prices down. All these issues are magnified in defined benefit plan environments.

    I know the main reason why companies don't hire new workers is because economic growth has been so low, but company pension problems are one "structural" issue affecting employment that might be dealt with creatively by central banks.

    If central banks believed their interest rate targets are credible (that they are higher than they are now), one form of QE would be they should be able make is pay companies cash now for shares in company pension plans, or, alternatively, promises of some proportion of worker contributions to those plans, which would be like a form of pension nationalisation.

    The price a central bank pays for the shares in the pension plans could be calculated fairly. Apart from the private-sector assets of the plan, which I'll assume the market prices fairly, of interest to me would be how to evaluate the prices on any government bonds (this is a Quantitative Easing-like problem). If the central bank believes bonds are undervalued compared to the market prices, it should be willing to pay more for pension plans than the current market price in proportion to the plan's share of government-backed assets. Pension plans are a good asset to have: workers regularly pay into them. Central banks shouldn't be too leery about purchasing them.

    I think both methods need to be tried. A higher proportion of pensions should be state backed, and central banks should consider a QE program of buying "shares" in company pension plans.


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