Friday, May 23, 2014

"Goldman Sachs on coping with negative rates"

A nice catch at FT Alphaville:
There’s a good note from Goldman Sachs this week on the implications of negative rates at the ECB.
But given that many of the points echo much of the discussion already featured on FT Alphaville for years, we’ll cut straight to the interesting bits.

Goldman agree there isn’t anything conceptually special about negative rates because bond math works with negative numbers (as it’s focused on real returns). However, they add, there is a specific reason why negative rates might have qualitatively different macroeconomic implications, unless controls on cash were put in place with them:

…the possibility for banks to arbitrage against negative rates by holding banknotes. If banks are to be charged for holding excess liquidity (as the imposition of a negative DF rate would imply), they have an incentive to hold banknotes to avoid that charge. This implies that a negative DF rate would prove ineffective (as banks switch excess liquidity into banknotes): arbitrage implies that market rates are bounded at zero.

Zero lower bound. Behind this so-called ’zero lower bound’ on nominal interest rates lie two assumptions: (1) the cost of holding banknotes is negligible; and (2) banknotes are supplied elastically by the monetary authorities. In principle, the central bank could impose a tax on banknote holdings (e.g., by cancelling a portion of banknotes on the basis of (a random draw over) their serial numbers)....MUCH MORE