Shadows
Real estate investors often use interest rates as part of their investment-decision making process. But strange things are happening to interest rates and the use, or not, of negative interest rates has been the focus of much attention. What should central banks do when they hit the “zero lower bound” should they pass through that lower bound, set a negative nominal rate and encourage banks to lend even further, rather than hold cash?
Negative interest rates are just one of the four “unconventional” central bank tools that the Bank for International Settlements reviewed in its 2019 report, the others being, lending operations, asset purchase programmes and forward guidance. With so many unconventional tools, how might you understand the “overall stance” of monetary policy if it can no longer be communicated in the headline central bank interest rate?
Enter Leo Krippner whose research* results are particularly relevant. At the moment, the results of his research are possibly more important to observe than the rates set by central banks as they try to indicate the overall stance of monetary policy taking into account the unconventional tools that central banks may use.
The research sets out to estimate a “shadow short rate” (SSR), one which reflects both conventional monetary policy (CMP) and unconventional monetary policy (UMP). In particular, the shadow short rate can turn negative when unconventional monetary policy tools are being used, even if the official rate is not negative. During periods of CMP, the shadow short rate estimate is closely aligned with the official short rate set by the central bank. However, in periods of UMP, like now, the SSR estimate can depart from the official short rate, even when a central bank has already set a negative rate.
These SSR estimates are freely available at Leo Krippner’s website and offer us some insight into the overall stance of monetary policy, using conventional and unconventional means.
If you visit Leo Krippner’s website, you will find that he estimates shadow short rates for eight regions: the US, the UK, the Euro Area, Japan, Canada, Switzerland, Australia, New Zealand.
These eight regions are shown in the chart. The black lines show the central bank rate and the red lines show the shadow short rate, or SSR.
At last count (the end of October 2020), all of them were negative; they ranged from around -1.2% to -3.5%. These negative levels reflect the unconventional monetary policy measures which have been put in place. Put another way, were the UMP measures not in place these would be the rates that the relevant central bank would have to set to produce the same overall monetary policy stance.
Interestingly, in each region (bar Australia and New Zealand) they have been lower (i.e. more negative) in the past.
The debate surrounding the setting of negative interest rates is likely to continue, but we are already there when it comes to SSRs in all eight regions for which the estimates are produced. In some instances, we have been in shadow land for a long time.
Note: black lines show central bank rates, red lines show shadow sort rates (SSR)
Source: Leo Krippner, International SSR estimates www.ljkmfa.com end October 2020
Copyright: Leo Krippner
*Krippner, Leo. (2013) “Measuring the Stance of Monetary Policy in Zero Lower Bound Environments.” Economics Letters, 118, 135–38.
*Krippner, Leo. (2015) “ Zero Lower Bound Term Structure Modeling: A Practitioner’s Guide. ” Palgrave-Macmillan.