Are the rising yields in JGBs a sign of an incipient expected real economic recovery? Are they a sign of the market being ahead of Abenomics? And what about the paradox, that on the one hand the massive bond-buying BoJ is seeing bond prices fall instead of rise, should they be concerned about the impact this has on their debt servicing costs?
On the one hand, the rational-investor-Kyle-Bass approach makes a bit of sense. If the BoJ is trying to drive up inflation to 2% (and erode the value of JGBs), this would imply the success (somewhat) of Abenomics and the selling of JGBs to buy foreign bonds/equities.
But this is similar to Richard Koo's balance sheet approach to doomsday. It's the same end but different means really. Once inflationary expectations pick up, the BoJ will essentially lose control of any ability to control a rise in yields. And then you can let your imagination run...loss of faith...beginning of the end...(insert apocalypse now scenario here).
It's pretty obvious that there's a time variant issue here. That economic recovery is relatively a more long-term implication than the volatility in interest rates. The reaction of the markets is immediate and often ahead of policy action. But if investors start selling, are they anticipating success or failure? And if long-term rate rises precede signs of real economic recovery, will lenders choke off borrowing and bring the whole experiment to an end?
Abe himself, is not one to discount the worrying impact of short-term volatility and rises in borrowing costs. In parliament, he said that, "sharp increases in long-term interest rates could have a grave impact on the economy and the government's fiscal conditions".
But perhaps Abe should not be overly worried at the moment. After all, the BoJ is the BoJ - a central bank with more in its arsenal.
And this sort of runs contrary to what Nick Rowe says over at Worthwhile Canadian Initiative. He claims that it's not just what you buy, but what you buy it with; and his example is paying for taxi medallions with newly produced bicycles. Thus, an increase in the stock of money in circulation (we have to be careful here!), will have an effect on the demand for bonds (by raising the expected future price level thus reducing the demand).
But the key here (and the paradox too!) is that if you're flooding the monetary base and forcing yields down in the hope that inflation expectations will pick up and spark a real recovery...and this will cause "a rise in investment, fall in savings..." and if you intend for all this to happen and will gladly accept the consequence of rising yields then are you really trying to force yields down in the first place? And if yields rise (we've come full circle here), has your policy succeeded or failed?
Rowe says that the easiest way to think about this (and he's mostly right) is that it's a battle to push bond yields down but a war for economic traction and recovery. Thus, if you win the war, you'll lose the battle and essentially, you'd want to lose that battle.
Because this we do know, that when and if the Japanese economy recovers from its deflationary trap and stagnant growth, nothing much can (and perhaps should) be done about an accompanying shift in the yield equilibrium. In that sense, the more any attempt is made, the higher it might rise. And if there's a real economic recovery (Not just expectations of it)? Then a new equilibrium might be the point at which the BoJ stops restraining yields.
So throw Econ 101 out of the window, which tells us that the more you buy of something, the higher its price goes. The expectations of Japanese and foreign investors could be different. As Noah Smith points out, JGB investors are largely Japanese which most equity flows have been driven by foreign funds. And in this sort of a Keynesian set-up, a rapid interest rate rise perhaps could only be explained by a multiple equilibria theory where "Abenomics kicks the economy out of its bad equilibrium very abruptly, and the economy is shocked back to a sustainably higher rate of nominal growth".
Thus, according to Smith, "Japan's only hope is to cause the kind of recovery where interest rates stay very low for a very long time". But he says this with the debt ratio in mind, assuming rationally that sharp rises in borrowing costs would have unwanted consequences on the fiscal position. From Rowe's point of view, this prolonged-low-rate environment will prove impossible by the design of its theory.
Lest we forget though, that instead of rises in nominal rates, the reason for the rise in nominal rates will impact the function of real interest rates. And if things seem to be working and Japan really kicks itself out of its deflationary liquidity trap then real rates will go down irrespective (barring a vigilante attack I suppose) and the real value of existing debt stock will be eroded even though debt-servicing costs rise.
In that sense, Koo is right but he's just a bit wrong too. With balance sheet constraints, budget deficits and NOT monetary policy moves are the solution but this ignores the fact that even in a balance-sheet scenario, there will be creditors who respond to lower real rates.
Once again, the key here is the time boundary. Volatility may not be something to be over-worried about and neither is the paradox. And therefore, betting on Abenomics to end up as a failure is definitely not the right move to make at the moment.
On the one hand, the rational-investor-Kyle-Bass approach makes a bit of sense. If the BoJ is trying to drive up inflation to 2% (and erode the value of JGBs), this would imply the success (somewhat) of Abenomics and the selling of JGBs to buy foreign bonds/equities.
But this is similar to Richard Koo's balance sheet approach to doomsday. It's the same end but different means really. Once inflationary expectations pick up, the BoJ will essentially lose control of any ability to control a rise in yields. And then you can let your imagination run...loss of faith...beginning of the end...(insert apocalypse now scenario here).
It's pretty obvious that there's a time variant issue here. That economic recovery is relatively a more long-term implication than the volatility in interest rates. The reaction of the markets is immediate and often ahead of policy action. But if investors start selling, are they anticipating success or failure? And if long-term rate rises precede signs of real economic recovery, will lenders choke off borrowing and bring the whole experiment to an end?
Abe himself, is not one to discount the worrying impact of short-term volatility and rises in borrowing costs. In parliament, he said that, "sharp increases in long-term interest rates could have a grave impact on the economy and the government's fiscal conditions".
But perhaps Abe should not be overly worried at the moment. After all, the BoJ is the BoJ - a central bank with more in its arsenal.
And this sort of runs contrary to what Nick Rowe says over at Worthwhile Canadian Initiative. He claims that it's not just what you buy, but what you buy it with; and his example is paying for taxi medallions with newly produced bicycles. Thus, an increase in the stock of money in circulation (we have to be careful here!), will have an effect on the demand for bonds (by raising the expected future price level thus reducing the demand).
But the key here (and the paradox too!) is that if you're flooding the monetary base and forcing yields down in the hope that inflation expectations will pick up and spark a real recovery...and this will cause "a rise in investment, fall in savings..." and if you intend for all this to happen and will gladly accept the consequence of rising yields then are you really trying to force yields down in the first place? And if yields rise (we've come full circle here), has your policy succeeded or failed?
Rowe says that the easiest way to think about this (and he's mostly right) is that it's a battle to push bond yields down but a war for economic traction and recovery. Thus, if you win the war, you'll lose the battle and essentially, you'd want to lose that battle.
Because this we do know, that when and if the Japanese economy recovers from its deflationary trap and stagnant growth, nothing much can (and perhaps should) be done about an accompanying shift in the yield equilibrium. In that sense, the more any attempt is made, the higher it might rise. And if there's a real economic recovery (Not just expectations of it)? Then a new equilibrium might be the point at which the BoJ stops restraining yields.
So throw Econ 101 out of the window, which tells us that the more you buy of something, the higher its price goes. The expectations of Japanese and foreign investors could be different. As Noah Smith points out, JGB investors are largely Japanese which most equity flows have been driven by foreign funds. And in this sort of a Keynesian set-up, a rapid interest rate rise perhaps could only be explained by a multiple equilibria theory where "Abenomics kicks the economy out of its bad equilibrium very abruptly, and the economy is shocked back to a sustainably higher rate of nominal growth".
Thus, according to Smith, "Japan's only hope is to cause the kind of recovery where interest rates stay very low for a very long time". But he says this with the debt ratio in mind, assuming rationally that sharp rises in borrowing costs would have unwanted consequences on the fiscal position. From Rowe's point of view, this prolonged-low-rate environment will prove impossible by the design of its theory.
Lest we forget though, that instead of rises in nominal rates, the reason for the rise in nominal rates will impact the function of real interest rates. And if things seem to be working and Japan really kicks itself out of its deflationary liquidity trap then real rates will go down irrespective (barring a vigilante attack I suppose) and the real value of existing debt stock will be eroded even though debt-servicing costs rise.
In that sense, Koo is right but he's just a bit wrong too. With balance sheet constraints, budget deficits and NOT monetary policy moves are the solution but this ignores the fact that even in a balance-sheet scenario, there will be creditors who respond to lower real rates.
Once again, the key here is the time boundary. Volatility may not be something to be over-worried about and neither is the paradox. And therefore, betting on Abenomics to end up as a failure is definitely not the right move to make at the moment.
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