What if Apple pegged its stock price at $1?

 Would it make sense for Apple to peg its stock price at $1? If so, how would it go about doing this?

From the perspective of shareholders, there's an advantage to a firm's shares being valued not only as a pure store of value but also as useful in trade, or as money. All things staying the same, the increase in demand that is created by the monetary usefulness of a share will ratchet up the multiple applied to a firm's earnings, resulting in a higher market capitalization and richer (and happier) shareholders. As long as the costs of making shares more moneylike aren't too high (I'll assume they aren't), Apple will prefer that its shares be ubiquitous and pervade all corners of an economy, much like a U.S. dollar note or a bank deposit.

The problem is that people aren't fond of unstable exchange media (see here & here). Bills and deposits tend to show low price variability. And because retailers keep prices sticky in terms of the unit of account, a $100 deposit or $100 bill is guaranteed to purchase $100 worth of stuff one month hence. Unlike bills and deposits, volatile assets like Apple shares can crater at any moment, thus ruining their effectiveness as a monetary medium.

Could Apple solve this problem? If Apple were to peg its stock price at $1, it would provide individuals with all the benefits of a dollar bill or deposit. Add in some infrastructure for allowing payment via stock (say a permissioned block chain), and demand for Apple shares would treble as they stole business from banks. Apple's market cap would spike.

What about investors, say hedge funds and mutual funds? Why would they want to own an asset that never deviates from $1? They need a return, after all, to justify holding Apple in their portfolio. The answer, in short, is that the peg wouldn't reduce Apple's return to zero; rather, it would change the form of the return. Instead of rewarding shareholders with a higher share price, Apple management would reward them by augmenting the quantity of stable-value shares they own.

Say Apple's earnings are to grow 10% over the course of a year. Without a peg, investors expect one share of Apple, currently trading at $1, to be worth $1.10 in one year, providing a 10% return. With a peg, investors will instead expect the quantity of $1 shares in their portfolio to grow from 1 to 1.1, thus providing the same 10% return. Think of the 0.1 increase in shares as a stock dividend to all existing shareholders.

If Apple has a blowout year and earnings grow 20% rather than just 10%, investor demand for Apple shares will rise, putting upwards pressure on the peg. Management will grant existing owners whatever extra stock dividends are necessary to relieve the pressure. Likewise, a rise in the monetary demand for Apple shares, perhaps due to a liquidity crisis, will by counterbalanced by a stepped up pace of stock dividends, ensuring the peg's integrity.

Conversely, downwards pressure on the peg will be relieved with a series of reverse stock dividends. Shareholders will find that, where before they had $1 share worth $1, they have been docked 0.01 shares and only have 0.99 shares worth $1 dollar.

For the public to accept Apple's pegged shares as an exchange medium, they need to suffer from some sort of money illusion. After all, even though Apple is enforcing its $1 peg and providing nominal stability, this is little more than an illusion. The reverse stock dividend mechanism threatens to reduce the quantity of shares in each individual's portfolios, thus diminishing their overall purchasing power. Will people be fooled by the $1 price? I don't know, but if so, Apple can increase its market capitalization for free and thus enrich its shareholders.

This leads into a bigger question that I'll let others try and answer. What quirks of human psyche (or institutions) lead publicly traded companies to universally set a floating stock price and a fixed quantity of shares? Why not let the quantity float and the price stay fixed? If we were perfectly logical beasts, we should be indifferent between the two.

Liquidity liquidity everywhere but not a drop to drink

One of Gustave Doré's illustrations of The Rime of the Ancient Mariner, plate 4

The minsicule bid ask spreads we see in financial markets today indicate that stocks and bonds have never been more liquid. At the same time, skeptics worry that the odds of a sudden evaporation of this liquidity has never been higher. This Jekyll and Hyde world of ultra liquidity coupled with heightened risk of liquidity famines is one of the core themes running through a great series of posts on market liquidity from Liberty Street, the NY Fed's blog. See here, here, and here.

To protect their portfolios, investors need to be able to look beyond the incredible amounts of potentially superficial liquidity coursing through markets and plan for future illiquidity crisis. For this sort of preparation to be possible, what investors really need is a market in long-dated liquidity-related financial products.

Central banks have historically been the chief providers of liquidity-related financial products, namely liquidity insurance, or the guaranteed use of central bank lending facilities in a crisis. The problem, as Stephen Cecchetti and Kermit Schoenholtz point out, is that we simply don't know if central banks are offering this financial product at the right price and in appropriate quantities. Cecchetti & Schoenholtz say that providing lending facility access: 

without limit and without penalty can lead to enormous moral hazard, causing overreliance on the central bank. If market participants are trained to ignore liquidity risk in good times, they will do little to make markets less fragile or to prepare themselves for unanticipated, but persistent episodes of market illiquidity.

The other problem is that central banks only provide liquidity insurance to banks. What about the rest of us? How can all investors, and not just bankers, benefit from properly priced liquidity insurance products?

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A central bank is a monopolist without much business sense. It has no idea how to set the proper price for insurance products. Which is why I think a private market in liquidity options, or liquidity insurance, may be an ideal solution.

How might these liquidity options look?

An option to sell at the ask price

In financial markets there is a price at which participants are willing to buy and a price at which they are willing to sell. This is the famous bid-ask spread, or bid-offer spread.

Say the bid, or buying price, for Google shares is $650 and the ask price is $660, the width of the spread being $10.

A seller with time on their hands will join the queue of sellers already at $660 and wait for a buyer to step forward. If the seller is desperate for liquidity, they will sell at $650 to the first buyer in the bid queue, absorbing the $10 loss. When a liquidity crisis hits, this spread may widen out such that a desperate seller will only be able to get out at $640, or $600.

Liquidity risk can be thought of as thusly: We'd all love to rapidly sell at the offer, or ask price, but reality forces us to trek the distance across the spread and sell at the bid. In normal times, who cares; the spread is miniscule. But this trek-to-the-bid gets much costlier in a crisis when spreads widen out.

A liquidity option would be designed to allow investors to do the impossible: sell rapidly at the offer price. Using the Google example from above, an investor who buys a Google liquidity option would be allowed to exercise the option and immediately buy Google from the option seller at the current market offer price, say $660, and not the bid price, say $650. If buyers were to flee and liquidity evaporate such that the level of bids falls to $600, the owner of the option is protected since they can sell Google at the offer price of $660, and not the much lower bid price of $600.

Think about it this way. Whereas a regular put option provides downside price protection by allowing the owner to sell at a fixed price, a liquidity option allows them to sell at a fixed spread. Buying liquidity protection for one Google share would probably be much cheaper than getting downside price protection for that same share.

What should the price of a liquidity option be? Say that the difference between Google's bid and ask is typically $10. An insurance writer who is is required to purchase Google from the option owner at the offer price can typically only offload this risk by turning around and selling Google at a $10 loss. They will therefore require an initial insurance payment, or premium, of at least $10 to compensate.

When a liquidity crisis hits the current bid-ask spread will widen and insurers will ask for higher premiums on newly issued insurance. If current liquidity stays healthy but the odds of future liquidity crisis increase such that future Google bid-ask spreads are expected to be quite wide, then the liquidity insurance writer will require more compensation as well. The value of a liquidity option depends on both current and expected illiquidity. Conversely, if liquidity risks are expected to decline, buyers will ask for lower premiums since they don't expect the insurance to offer much protection over its contract life.

Those investors who have hedged against liquidity risk by buying liquidity options need never fear illiquidity again. If liquidity stays healthy their liquidity options will expire worthless but they'll have no problems exiting their positions. If liquidity deteriorates they can no longer exit their positions directly by selling on the market but can just as easily get liquid by exercising their options.

In addition to Google, a well designed liquidity market would have liquidity options on all major equities, ETFs, and widely traded fixed income products. Full democratization of liquidity insurance would be achieved by having these options trade on public markets. Information about the price of liquidity would become widely available so that investors could "internalize liquidity risk", as Cecchetti & Schoenholtz put it. If they didn't like the risks they found themselves facing, investors could use these products to reorient themselves. Take a family with a mortgage that was too afraid to buy Google because of the potential for an outbreak of illiquidity at the same time that a mortgage payment comes due. The can now own shares and hedge away their liquidity risk by purchasing a liquidity option. Folks like Warren Buffett, a conservative investor with a strong balance sheet capable of withstanding liquidity crisis, would be able to earn extra income by writing liquidity options and collecting premia.

In sum, with a well designed liquidity options market, the risks of illiquidity are distributed to those who want to bear them and away from those who don't. Markets will probably be much less fragile. As for central banks, with the market providing both liquidity insurance and liquidity pricing, central bankers can focus much more on what they should be doing; monetary policy.

Are prices getting less sticky?

Sticky prices illustrated, from Eichenbaum, Jaimovich, and Rebelo (link)

What makes ride sharing firm Uber interesting is not just its use of new technology to mobilize unused car space, but the method it uses to price its services. Uber's surge pricing algorithm varies cab fares dynamically. To get from A to B, the car that you hired this morning for $10 could end up costing $100 this afternoon.

How unlike the traditional taxi fare it is displacing! In their 2004 paper on sticky prices, economists Bils and Klenow found that taxi fares tended to remain at the same level for 19.7 months before being adjusted. Getting from A to B pretty much costs you the same price day-in-day-out for almost two years.

In our internet age, are prices getting less sticky? 

At first glance no. Alberto Cavallo, who along with Roberto Rigobon created the Billion Prices Index (the bane of all inflationistas), has analyzed scraped data from the websites of retailers who continue to sell mostly through bricks & mortar stores, say like Walmart. Cavallo finds that U.S. online prices stay fixed for 42 days, about the same as offline prices.

On the other hand, Gorodnichenko, Sheremiro, and Talavera find that online prices exhibit more flexibility than offline prices. Unlike Cavallo, the authors analyze data from an online-only store, say like an Amazon (they aren't permitted to disclose which store). However, while Gorodnichenko et al find that online prices are less rigid than bricks & mortar prices, they still exhibit unusually long price spells, or periods of fixity. These spells tend to endure for about 7 to 20 weeks, two-thirds shorter than offline spells when the effect of discounts/sales has been removed. The result is counter-intuitive, say the authors, given that online stores have the technology to cheaply adjust prices as supply and demand change, yet for some reason choose not to.

Even though both papers were published in 2015, Cavallo and Gorodnichenko are using relatively stale data. The first dataset runs between October 2007 and August 2010 while the latter spans the period between May 2010 and February 2012. This delay is unfortunate as the online world is changing fast. Recent industry articles point to a large ramp-up in the use of dynamic pricing by retailers over the last few years. For instance, Profitero, a price intelligence provider, charts out a step-wise change in the pace of Amazon's price changes beginning in late 2012. According to competing price intelligence company 360pi, by 2014 some 18% of Amazon's prices were changing daily.

The same goes for an old dinosaur like Sears. While Sears' online prices rarely underwent changes in the earlier part of this decade, around 18% of its prices are now being adjusted each day, on par with Amazon. And now Sears is trying out digital signs in its bricks & mortar stores to ensure quicker offline price changes.

The moral economy

If we are indeed entering an Uber-style flex-price world, what underlying factors had to change for this to happen? It's not technology—we've always had the means to set rapidly changing prices, just look at financial markets. If anything had to bend in order for pricing patterns to change, it was the ethics of price setting.

To understand why, we need to explore one of the enduring questions in economics: why goods & services prices remain fixed in the face of continuously changing demand and supply conditions. When economist Alan Blinder polled businesses in the early 1990s to find out why they kept prices unchanged for long periods of time, the most common answer was the desire to avoid "antagonizing" customers or "causing them difficulties." Blinder's findings evoked Arthur Okun's earlier (1981) explanation for sticky prices whereby business owners maintain an implicit contract, or invisible handshake, with customers. If buyers view a price increase as being unfair, they might take revenge on the retailer by looking for alternatives. A retailer who promises to adjust prices rarely and only when costs justify it thereby avoids antagonizing customer sensibilities, and in return the customer provides a degree of loyalty.

The idea that prices are set within an overall moral framework predates Blinder and Okun. Nobel Prize winning economist John Hicks, for instance, once wrote that the notion that all prices are perfectly flexible was highly unrealistic and attributed rigidity to legislative control, monopolistic action "of the sleepy sort which does not strain after every gnat of profit, but prefers a quiet life," and "lingering notions of a ‘just price’."

Hicks' use of the word 'lingering' refers to the extended lineage of the concept of the just price. The belief that it is in some way sinful to sell a product for more than its fair price is a very old one, going back to early economic thinkers like Thomas Aquinas. In the age that Aquinas inhabited the economic roles that individual were permitted to play and the prices they could set were determined by tradition and custom. Historian E.P Thompson once referred to this as the "moral economy." For example, medieval English farmers could not sell their corn directly from their fields but had to bring it in bulk to the local "pitching market." Speculation, or the practice of "withholding" in the anticipation of better prices, was prohibited. Once at market, no sales of corn could be made before stated times. When the bell rang, the poor had the first chance to buy, and only after could larger dealers make purchases. These various market structures were designed to ensure a just price and fair profits.

Even as these structures were slowly unwound, writes Thompson, the English populace clung to the old morality, the physical incarnation of this being food riots which swept the countryside during the 18th century. These riots weren't random attempts to pilfer. Rather, they were relatively sophisticated affairs whereby rioters would organize to set the price of a good, in effect forcing the offending retailer to sell their wares at the level deemed just rather than at its much higher market-determined rate.

In the same way that 17th century rioters self-regulated markets by threatening to set the price for corn or bread, modern shoppers who encounter an unjust price threaten to cross the aisles towards the competition. Eager to avoid being punished by their customers' wrath, retailers implicitly promise to keep their prices fixed for long periods of time.

I find it interesting that even when we start from scratch, the notion of a just price quickly emerges. In his account of a temporary P.O.W. camp economy in which cigarettes circulated as money, R.A. Radford notes that:

There was a strong feeling that everything had its "just price" in cigarettes. While the assessment of the just price, which incidentally varied between camps, was impossible of explanation, this price was nevertheless pretty closely known. It can best be defined as the price usually fetched by an article in good times when cigarettes were plentiful. The "just price" changed slowly; it was unaffected by short-term variations in supply, and while opinion might be resigned to departures from the "just price," a strong feeling of resentment persisted. A more satisfactory definition of the "just price" is impossible. Everyone knew what it was, though no one could explain why it should be so.

Behavioral economists also find evidence of a just price mentality. Using telephone surveys, Kahneman, Knetsch, and Thaler were able to isolate community standards of price fairness. Generally, consumers feel they are entitled to their reference price, or past price. They also believe firms are entitled to their reference profit and deem it fair for a firm to raise prices to protect that profit, say because the firm's costs have increased. A firm that takes advantage of an increase in demand by raising its price and makes more than its reference profit is, however, breaking the rules of the game and acting unfairly.

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So let's bring this back to Uber surge pricing and Amazon/Sears dynamic pricing.

I see two angles here. After centuries of a just price morality, perhaps we are inching towards an alternative framework. Maybe we've finally overcome our revulsion to an 'unfair price' that varies according to fluctuations in demand. Instead of the 19.7 month price spells of yore, we're now willing to endure 19.7 minute price spells. Morality changes, after all; slavery and death penalties used to be common, abortion was prohibited. If so, Uber and Amazon's pricing policy are emblematic of this underlying morality switch.

Or maybe we haven't switched at all and are still operating under the old rules of the moral economy. If so, the new pricing technologies adopted by Amazon and Uber are destined to be met by a titanic wave of consumer revulsion. This may be already happening; Uber's surge pricing policy has attracted plenty of negative press (here and here). Morality is a powerful force; unless they want to be dashed to pieces, the offenders will have to relent and make their prices more sticky.

How I learned to stop worrying and accept deflation

Why can't we create inflation anymore? Maybe it's because money isn't what it used to be.

Money used to be like a car; the market expected it to depreciate every day. When we buy a new car we accept a falling resale value because a car provides a recurring flow of services over time; each day it gets us from point a to point b and back. And since these conveniences are large, the market prices cars such that they yield a steady string of capital losses.

Money, like cars, used to provide a significant flow of services over time. It was the liquidity instrument par excellence. If a problem popped up, we knew that money was the one item we could rapidly exchange to get whatever goods and services were necessary to cope. Given these characteristics, the market set a price for money such that it lost 2-3% every year. We accepted a sure capital loss because we enjoyed a compensating degree of comfort and relief from having some of the stuff in our wallets.

These flows of services are called a convenience yield. Assets that throw off a convenience yield, like cars and money, typically have negative expected price paths. Let's call them Type 1 assets.

Type 2 assets, things like stocks and bonds, don't boast a convenience yield. Without a convenience flow, people only buy them because they promise a real capital return. One way a Type 2 asset provides a capital return is via a positive expected price path. We only hold Google shares because we expect them to rise by around 5-10% a year. Same with treasury bills. The government issues a bill at, say, $97, and they mature a year later at $100.

Another way for a Type 2 asset to provide a capital return is via periodic payments. A bond or an MBS doesn't rise over time. Rather, it provides its return in the form of regular coupon payments.

Could it be that money has steadily lost its convenience yield? If so, it's shifted from being a Type 1 asset with a negative expected price path towards being a Type 2 asset. That would explain our new deflationary era. In the same way that Type 2 assets like Google and t-bills have to offer a positive expected price path if they are to be held, the purchasing power of money needs to improve over time. And since everything in the world is priced in terms of money, that means that the price level can no longer inflate, it has to deflate.

Where has money's once considerable convenience yield gone? The costs of creating liquidity have been steadily diminishing. Wall Street has been able to make a wide variety of assets like stocks and bonds much more liquid at less cost. So whereas money was once the liquidity instrument par excellence, people now have a multitude of liquid instruments that they can choose from. At the same time, central banks, via quantitative easing, have create massive amounts of central bank liabilities. With a sea of liquid assets, maybe liquidity just isn't a valuable commodity anymore.

Welcome to deflation, folks. Into the vacuum left by money's retreating convenience yield, a promise of capital returns has sprung up.

Reversing deflation?

Even if money has become a Type 2 asset, central bankers can still get the inflation rate back to 3%. To do so, they'd have to change the nature of the capital return that it offers. Like Google shares, money now seems to promise a rising expected price path (i.e. deflation). Central bankers need to switch that out with a bond-style promise of juicier periodic payments. This would involve a central banker ratcheting up the interest rate on money balances, or reserves, to an above-market level. Only with an unusually high interest rate on reserves would people once again accept a declining expected price path for money (i.e. inflation).

For an analogy, imagine that tomorrow the U.S. Treasury were to issue a new 10-year bond with an outlandishly high 10% coupon. With the market-clearing yield on existing 10-year bonds sitting at just 2%, the new bond would start trading at a large premium to its $1000 face value and slowly fall over time. Likewise, money that sports an outlandishly high interest rate would steadily lose purchasing power. 

Ratcheting up rates in order to get us back to a 3% inflation path could be a ghastly experience. Before it can start rolling down the hill again, money's purchasing power would have to rise sharply in value. But money is the unit in which everything else is priced, which means the price level would need to rapidly deflate. If prices are sticky, this could result in a glut of unsold labour and goods; a recession.

Alternatively, might a central bank rekindle inflation by forcing interest rates below their market level? In the short term we'd get a quick one-time dose of inflation. But after the adjustments had been made the price level would only continue its previous deflationary descent. A central banker would have to consistently ratchet down interest rates to generate a perpetual series of one-time inflationary pops in order to keep hitting its 2-3% inflation target. This strategy would run into problems. Go much below -1% and a central bank will hit the lower bound. Unless it wants to risk mass cash storage, it won't be able to go further. Even if a central bank devises ways to get below -1%, it'll have to perpetually ratchet rates down in order to spur the next one-time pop in inflation. Once it hits -20%, or -30%, one wonders whether the market won't simply adopt an alternative currency.

Given that these two options don't seem too comforting, maybe we should just get used to a bit of deflation.


Tony Yates responds here and here.

Andy Haldane and BOEcoin

The 1995 British two pound "Dove" coin

The Bank of England's chief economist Andrew Haldane recently called for central banks to think more imaginatively about how to deal with the technological constraint imposed by the zero lower bound on interest rates. Haldane says that the lower bound isn't a passing problem. Rather, there is a growing probability that when policy makers need three percentage points of headroom to cushion the effects of a typical recession, that headroom just won't be there.

Haldane pans higher inflation targets and further quantitative easing as ways to slacken the bound, preferring to focus on negative interest rates on paper currency, a topic which gets discussed often on this blog. He mentions the classic Silvio Gesell stamp tax (which I discussed here), an all out ban on cash as advocated by Ken Rogoff, and Miles Kimball's crawling peg (see here).

According to Haldane, the problem with Gesell's tax, Rogoff's ban (pdf), and Kimball's peg is that each of these faces a significant 'behavioural constraint.'  The use of paper money is a social convention, both as a unit of account and medium of exchange, and conventions can only be shifted at large cost. Tony Yates joins in, pointing out the difficulties of the Gesell option. Instead, Haldane floats the possibility of replacing paper money with a government-backed cryptocurrency, or what we on the blogosphere have been calling Fedcoin (in this case BOEcoin). Unlike cash, it would be easy to impose a negative interest rate on users of Fedcoin or BOEcoin, thus relaxing the lower bound constraint. Conventions stay intact; people still get to use government-backed currency as a medium of exchange and unit of account.*

While I like the way Haldane delineates the problem and his general approach to solving it, I'm not a fan of his chosen solution. As Robert Sams once pointed out, Fedcoin/BoEcoin could be so good that it ends up outcompeting private bank deposits, thus bringing our traditional banking model to an abrupt end. Frequent commenter JKH calls it Chicago Plan #37, a reference to a depression-era reform (since resuscitated) that would have outlawed fractional reserve banking. If Haldane is uncomfortable with the Gesell/Rogoff/Kimball options for slackening the lower bound because they interfere with convention, he should be plenty worried about BOEcoin.

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I do agree, however, with Haldane's point that the apparatus adopted to loosen the constraint should interfere with convention as little as possible. We want the cheapest policies; those that only slightly impede the daily lives of the typical Brit on the street while securing the Bank of England a sufficient amount of slack.

With that in mind, here's what I think is the cheapest way for the Bank of England to slacken the lower bound: just freeze the quantity of £50 bills in circulation. Yep, it's that easy. There are currently 236 million £50 notes in circulation. Don't print any more of them, Victoria Cleland.**

I call this a policy of embargoing the largest value note. How does it work?***

Say that in the next crisis, the Bank of England decides to chop rates from 0.5% to -2.0%. Faced with deeply negative interest rates, the UK runs smack dab into the lower bound as Brits collectively try to flee into banknotes. After all, banknotes offer a safe 0% return, the £50 note being the chosen escape route since those are the cheapest to store and convey.

Flooded with withdrawal requests, banks will quickly run out of £50s. At that point the banks would normally turn to the Bank of England to replenish their stash in order to fill customers' demands. But with the Bank of England having frozen the number of £50s at 236 million and not printing any new ones, bankers will only be able to offer their customers low denomination notes. But this will immediately slow the run for cash since £20s, £10s, and £5s are much more expensive to store, ship and transfer than £50s. Whereas people will surely prefer a sleek high denomination note to a deposit that pays -2%, they will be relatively indifferent when the choice is between a bulky low denomination cash and a deposit that pays -2%. Thus the lower bound has been successfully softened by an embargo on the largest value note.

Once negative interest rates have served their purpose and the crisis has abated, they can be boosted back above 0% and the central bank can unfreeze the quantity of £50s. Everything returns to normal.

A few conventions will change when the largest value note is embargoed.

1. People will no longer be able to convert £50 worth of deposits into a £50 note. Instead they'll have to be satisfied with getting two £20s and a £10. That doesn't seem like an expensive convention to discard. And if folks really want to get their hands on £50s, they'll still be able to buy them in the secondary market, albeit at a small premium.

2. In normal times, £50 notes always trade at par. Because their quantity will be fixed under this scheme, £50s will rise to a varying premium above face value whenever interest rates fall significantly below zero. For instance, at a -2.0% interest rate a £50 note might trade in the market at £51 or £52.

The par value of £50 notes is a cheap convention to overturn. The majority of the British population probably don't deal in £50s anyways. Those who do use £50 notes in their daily life will have to get used to monitoring their market price so that they can transact at correct prices. But the inconveniences faced by  this tiny minority is a small cost for society to pay in order to slacken the lower bound.

3. Importantly, there will be no need to proclaim a unit of account switch upon the enacting of an embargo on £50s; the switch will be seamless.

Because the £50 was never an important part of day-to-day commercial and retail existence, come negative interest rates no retailers will set their prices in terms of a £50 standard. If they do choose to set sticker prices in terms of the £50 note, they will find that if they want to preserve their margins they will have to levy a small surcharge each time someone pays with £20s, £10s, and £5s and bank deposits. Given the prevalence of these payment options, that means surcharging on almost every single transaction. That's terribly inconvenient. Far better for a retailer to set sticker prices in terms of the dominant payments media—£20s, £10s, and £5s and bank deposits—and provide a small discount to the rare customer that wants to pay with £50s.

It's entirely possible that the majority of retailers will not bother offering any discount whatsoever on £50s. This would effectively undervalue the £50 note. Gresham's Law tells us that given this undervaluation, the £50 will disappear from circulation as it gets hoarded under people's mattresses. For the regular British citizen, never seeing £50s in circulation probably won't change much. And anyone who does want a £50 can simply advertise on Craig's list for one, offering a high enough premium to draw it out of someone's hoard.

In closing, a few caveats. The figures I am using in this post are ballpark. It could be that a policy of freezing the supply of £50 notes allows the Bank of England to get to -2%. But maybe it only allows for a level of -1.75%, or maybe it slackens the bound so much as to allow a -2.5% rate.

Haldane mentions that the Bank of England could need 3% of headroom to combat subsequent recessions. But as Tony Yates has pointed out, in 2008 bank officials calculated that a -8% rate was needed. The Bank could get part way there by not only embargoing the £50 but also the next highest value note; the £20. But that probably wouldn't be enough. As ever smaller notes have their quantities frozen, this starts to intrude on the lives of the people on the street, making the policy more costly. If it needs to slacken the lower bound in order to allow for rates of -8%, I think the Bank of England should be planning for a heftier policy like Miles Kimball's crawling peg. After all, when the sort of crisis that requires such deeply negative rates hits, the last thing we should be worried about is disturbing a few conventions. Until another 2008-style crisis hits, embargoing large value notes might be the least intrusive, lowest cost option. 

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*Of these policies, I think Miles Kimball's plan is by far the best one.
**Specifically, the Bank would only print new bills to replace ripped/worn out bills. Otherwise the outstanding issue will wear out and become easier to counterfeit. As for Scotland, which issues 100 pound notes, their quantity would have to be fixed as well.
*** I first mentioned the idea of embargoing large notes in relation to the Swiss 1000 CHF note, and later elaborated on it in the Lazy Central Banker's Guide to Escaping Liquidity Traps.

Hike rates when you hear the creak of inflation at the door, not when you see the whites of its eyes

A common argument against the Fed raising interest rates next week is the asymmetry in risks that it faces. If it keeps rates low too long and sets off inflation, no problem: it can quickly hike rates a few times to bring prices back in line. However, if it boosts rates too early and an unintended slowdown sets in, the Fed won't have room to cut a few times in order to fix its mistake. That's because the Fed is at the zero lower bound, the edge of the world in monetary policy terms. To avoid this conundrum, the Fed should hold off as long as possible before raising, at least until it "sees the whites of inflation's eyes."

As Paul Krugman points out, the asymmetry argument is only a recent one. Historically U.S. interest rates have hovered far above zero. If the Fed made a mistake, it didn't have to worry about falling off the edge of the world in order to fix the situation, it could simply ratchet rates down a few times. Rather than waiting till the last minute to see the whites of inflation's eyes before hiking, the FOMC only had to hear the creak of inflation at the door.  

I don't buy the current asymmetry argument. I might have bought it back in 2013, but the data has changed.

Over the last year, Sweden, Switzerland, Denmark, and the ECB have all demonstrated to the world that central banks can safely lower rates into negative territory without setting off the sorts of ill effects that economists have always feared, the main one being a race into 0% yielding cash. The theory here is that if a central bank reduces rates to, say, -0.1%, then paper cash—which pays a superior 0% return—starts to look pretty attractive. An arbitrage process begins whereby central bank deposits are converted into cash until all deposits have disappeared. Thus rates can't be reduced below 0%.

Evidence over the last 12 months shows otherwise. Denmark's Nationalbank has kept its deposit rate at -0.75% since early February. Danes, however, are not scrambling for banknotes, as the chart below shows. After seven months of negative rates, cash and coin outstanding are growing at a rate that lies pretty much at its two decade average.

The Swiss National Bank has maintained a -0.75% overnight rate since January, yet there's been no spike in Swiss paper franc demand, as the next chart shows. In fact, cash outstanding seems to be growing at one of its slowest rates in years.

We'd expect the demand for Swiss cash to be especially sensitive when interest rates fall below zero because the SNB issues the world's largest value banknote; the hefty 1000 sFr. The more valuable the banknote the lower the cost of storing wealth in cash form. These carrying costs are particularly important in determining the profitability of flight into cash at negative interest rates. A central bank can push rates a sliver below 0% without setting off a flight out of deposits into banknotes as long as there are inconveniences in storing cash. The greater these inconveniences, the larger that sliver.

The fact that the SNB has been able to keep rates at -0.75% for seven months now without setting off a stampede into 1000 notes indicates that the burdens of holding Swiss currency are higher than everyone had previously thought. It would seem that investors would rather lose 0.75% each year than bear the costs of storing 1000s. At some negative interest rate, maybe -1.5%, the flight into Swiss notes will start. But it hasn't yet. As for the U.S., its highest value banknote is the lowly $100, so it's fair to assume that the costs of storing U.S. paper money are significantly higher than Swiss money. Which means that if the Swiss can safely cut to -0.75% without setting off cash arbitrage, the Fed should be able to descend to at least -1.0% before panic ensues.

The second greatest fear surrounding sub zero U.S. rates has always concerned money market mutual funds. The worry here is that should the Fed reduce rates too deep, a financial intermediary known as a money market mutual fund (MMMF) will 'break the buck,' causing panic and terror among ordinary investors.

MMMFs are like regular mutual funds except their share price stays fixed at US$1.00. Investors can cash out at that price whenever they want, enjoying low but steady dividend payments until then. MMMFs maintain par conversion by investing in safe, highly liquid short term debt. However, if the Fed were to drive short term rates into negative territory, MMMFs would be forced to invest in assets that promise a negative return. $1000 invested in t-bills, for instance, would be worth only $999 upon maturity. That means that an MMMF simply wouldn't have a sufficient quantity of assets to allow everyone to redeem their shares at US$1.00. The fund will "break the buck," or mark its share value down to something like 99 cents to allow for full redemption. Since MMMFs are supposed to be cash-like—in fact, many of them offer cheque-writing capability—such a development would be disastrous, or so goes the story.

I don't consider breaking the buck to be a terrible outcome, but even if it is, European money market mutual funds—faced with negative interest rates—have already found an ingenious way to avoid it; a Reverse Distribution Mechanism. Rather than reducing redemption below par, MMMFs simply dock the number of shares that each shareholder has in his or her account. For example, as rates slide below zero, instead of 100 units being worth only $0.99 each, a shareholder forfeits one unit and ends up with 99 units worth $1.00 each. The deeper rates fall, the less units each investor owns. The genius of this patch is that the purchasing power of each share stays constant, but the negative interest rate is efficiently passed on to the owner of the MMMF.

So fears of a dash into cash at 0% and a collapse of MMMFs are just bogeymen. If the Fed hikes to 0.5% this month—and this proves to be a mistake—it still has plenty of room to make things right. Given how well Europe has coped over the last twelve months, the Fed can easily cut rates another 1.5% to -1.0%; that's six quarter-point reductions or thirty ten-point cuts. Only when rates falls beyond Swiss or Danish levels, say to -1.0%, will the Fed find itself in truly asymmetrical territory. (If necessary, here are some simple ways to allow for even more negative rates).

To be clear, that doesn't mean I think the Fed should hike rates next week. The fact that the FOMC continues to undershoot its 2% core inflation target would seem to indicate that holding off might be the right thing to do. Rather, I don't think that Fed policy makers need to wait to see the white's of inflation's eyes before they hike, they need only wait to hear the creak of inflation at the door.

Why big fat Greek bank premiums?

National Bank of Greece depository receipt certificate (source)

If you're like me and you like to: 1) explore anomalies in markets; and 2) mix equity analysis with monetary analysis, then you'll like this post. A sneak peak: by the end, we'll be able to use equity markets to figure out the unofficial exchange rate between a Greek euro and non-Greek euro.

For the last few weeks shares of Greek banks have diverged dramatically from their overlying depository receipts (see chart below). A bit of background first. A depository receipt is much like an exchange-traded fund, except where an ETF holds a bundle of different stocks, a depository receipt represents just one stock. That stock is usually listed on an out-of-the-way market (like Greece), whereas the depository receipt trades on a major exchange like New York. Investors interested in owning a foreign stock can avoid currency conversion costs and foreign settlement problems and instead purchase the New York-listed depository receipt hassle-free.

In general, the parent security and its offspring should trade in line with each other. Recently, however, the US-listed depository receipts of the National Bank of Greece and Alpha Bank have risen to a massive premium relative to their Greek-listed parents. For instance, in mid-August investors could have bought National Bank's New-York listed depository receipt for €0.73. However, the Greek-listed stock was trading for just €0.60. For some reason, investors are paying 30% more for a security that provides the exact same stream of earnings. We've got a gross violation of the law of one price.*

This is especially interesting given that a redemption/creation mechanism for depository receipts links the price of parent and offspring via arbitrage. In the same way that an investor deposits cash at a bank and gets a bank deposit, an investor can buy a National Bank of Greece share listed in Athens and 'deposit' that share at a custodian, receiving in return a newly-created New York-listed depository receipt. If either security can be bought for less than the other, an arbitrage opportunity arises. For instance, in mid-August one might (in theory) have bought Greek-listed National Bank of Greece shares for €0.60, converted them into New York-listed depository receipts, sold the depository receipts for €0.73, wired the proceeds from New York to Greece, and repurchased Greek-listed National Bank of Greece shares for €0.60. Rinse and repeat. (This works the other way, too. In the same way that a bank deposit can be converted into cash, investors can purchase a depository receipt and redeem it for underlying equity.)

The effect is that as investors clamour to harvest arbitrage gains, any premium or discount between a New York-listed depository receipts and its Greek parent equity should quickly fall towards zero. Why hasn't this been the case in Greece of late?

There are several explanations for persistent premia/discounts between depository receipts and their underlying shares. The first is liquidity differences. If the depository receipt is more liquid than the underlying equity, then investors will be willing to pay a bit more for the depository receipt. In the case of National Bank of Greece, the depository receipt tends to attract higher trading volumes than the underlying Athens-listed shares, which probably explains why the receipts have tended to trade at a premium.

Premiums or discounts can also occur when the redemption/creation mechanism is inhibited. Depository receipts for Taipei-listed Taiwan Semi Conductor rose to an incredible 60% premium to the shares in the late 1990s and early 2000s. The reason for this premium can be traced to the fact that Taiwan restricts foreign ownership of local companies. This effectively prevented the closing of the premium via purchases of local shares for conversion into depository receipts. These premia evaporated when Taiwan removed foreign ownership restrictions in 2003. (Here is a good summary).

In a 2006 paper, Saxena found that the New York-traded depository receipts of a handful of Indian stocks, including Infosys, Wipro, State Bank of India, MTNL, ICICI Bank, HDFC Bank and Satyam Computers, habitually traded at substantial premium to the underlying Indian-listed equity. Infosys's premium (which reached 60% in 2002) had existed since its U.S. listing in 1999. However, German, South Korean, and Hong Kong-listed companies with New York-listed depository receipts showed negligible premia.

Why was this? Saxena found that Indian depository receipts suffered from limited two-way fungibility. Depository receipts could be freely converted into Indian-listed shares, but Indian-listed shares could only be converted into depository receipts to the extent that there was available 'head room'. The amount of headroom in turn depended on the extent of past conversion of depository receipts into shares. Since headroom in the above shares had been all used up, when American investors flocked to buy depository receipts, thus driving them to a premium relative to the Indian-listed equity, there was no way for arbitrageurs to close the difference.

In the case of Greece, the imposition of capital controls on June 29 seems to have inhibited the redemption/creation mechanism. The Athens stock exchange was closed the same day (the New York-listed receipts continued to trade), but when it reopened on August 3, capital controls remained in place. Since reopening, a wedge has appeared between the prices of National Bank of Greece's depository receipts and its underlying shares, implying that there has been much more demand for the former than the latter. Typically, arbitrageurs would close this gap, buying the underlying Athens-listed shares and turning them into new deposit receipts. Presumably the Greek authorities have asked that banking intermediaries cease allowing the conversion of Greek shares into receipts, so arbitrage has not been possible.

That ended on August 27, 2015. According to a press release for BNY Mellon, clarification requested from Greek authorities regarding conversions of depository receipts had finally been received and, as a result, deposit receipt books would be re-opened for issuance and cancellation. With the ability to arbitrage receipts and the underlying shares once again available, the National Bank of Greece depository receipt premium collapsed from around 30% to 10% when markets opened on August 28. It has been shrinking ever since and now lies within its historical range.

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That explains the anomaly and its disappearance. But that's not the end of the story. Going forward, watching the relative price of National Bank of Greece's depository receipts and its share price may provide valuable insights.

In permitting depository receipt redemption and creation, the Greek government has effectively removed capital controls. Currently, Greeks cannot withdraw more than €420 in cash per week from their bank accounts and are not permitted to transfer more than €500 per month to a foreign account. Businesses must go through tedious application processes to get access to their funds. However, with the depository receipt window open, businesses and individuals can simply spend all their bank deposits on Athens-listed National Bank of Greece, convert the shares into depository receipts, sell them in New York for dollars, and convert the funds back to euros. Voila, capital controls evaded.

This loop hole doesn't seem very fair to me. After all, only the financial elite will be aware of the depository receipt escape, with widows, orphans, and the rest oblivious that capital controls have been effectively lifted. Loosening up the depository receipt window only make sense if it is twinned with similar effort to help the broad public, say a higher ceiling on cash withdrawals.

Depending how tightly Greece's capital controls bind, Athens-listed National Bank of Greece shares might actually lose their traditional discount and rise to a premium relative to New York-listed depository receipts (in euro terms). If depository receipts are the best route to evade capital controls, then those desperate to get their money out of Greece will be willing to pay a 'fee' for that privilege. By purchasing National Bank of Greece shares in Athens for, say 0.65 euro, and converting them into depository receipts that trade for just 0.60 euros, investors effectively lose 0.05 euros. The size of that fee, the premium, will equal the cost of the next best alternative for evading capital controls. If controls are leaky, the premium will be small. If they aren't, it could be quite wide.

A number of studies have found that during the Argentinean corralito, Buenos Aires-listed shares rose to a huge premium relative to their New York-listed depository receipts. Brechner, for instance, finds that the premium reached over 40% in January 2002. This gap represented the amount that Argentinians were willing to pay to use depository receipts as a vehicle for moving their wealth from frozen Argentinean bank deposits into liquid U.S bank deposits. When share conversions were restricted in March 2002, that premium disappeared.

Greece seems on its way to being mended. Capital controls should be loosened soon, and people no longer seem anxious about an imminent drachma conversion. So if a premium on local National Bank of Greece shares were to develop, I doubt it would be large like the sort of premia that prevailed in Argentina. However, if things were to get worse, we might see a large gap develop.

In closing, now that depository receipt conversion has been reopened but capital controls remain in place, the exchange rate between Athens-listed National Bank of Greece shares and New York-listed depository receipts serves as the "black market" rate between Greek euros and non-Greek euros. After Hugo Chavez imposed capital controls in 2003, Venezuelans used the rate between Caracas-traded CA Nacional Telefonos de Venezuela (CAN TV) shares relative to New York-listed depository receipts as a shadow rate for the Venezuelan bolivar, until CANTV was nationalized in 2007. Likewise burdened by capital controls, Zimbabweans used the exchange rate between Old Mutual shares listed on the Zimbabwe Stock Exchange and those listed in London as the implicit Zimbabwe dollar exchange rate. It even had a name: the OMIR, or Old Mutual Implied Rate.

So watch the National Bank of Greece equity-to-depository receipt rate closely. It's conveying information about Greek euros.


* More accurately, the depository receipts were trading for US$0.83. To calculate their euro price, I use the 9:30-10:30 price of New York-listed National Bank of Greece depository receipts and converted them into euros at the prevailing dollar-to-euro exchange rate.

Negative skewness, or: bulls walk up stairs, bears jump out of windows

Recent market action is a good reminder of the asymmetry in markets. In general, stock market rises don't look like stock market declines. Stock indexes slowly eke out gains over a period of months, but lose all of those gains just a few days. There are plenty of famous meltdowns in stocks, including 1914, 1929, 1987, and 2008, but almost no famous "melt ups."

Just like the Inuit have multiple words for snow because they are surrounded by the stuff, equity commentators have many words for crashes (panics, selloff, etc). These events are not uncommon. In the same way that many indigenous African languages have no word for snow, we lack a good word to describe one or two day melt-ups in equity markets since these aren't part of our landscape.

There are a number of trader's adages that describe this pattern, including bulls walk up the stairs, bears jump out the window and variations on that theme. In the economic literature, this phenomenon is referred to as negative skewness. If you look at the distribution of daily percent returns for the S&P 500 Index over a long period of time, you'll notice that there are more extreme negative results than extreme positive results, with the majority of results being slightly positive. Whereas a normal distribution, or the bell shaped curve we've all seen in statistics class, is symmetrical with 95% of values dwelling within two standard deviations of the mean, a negatively skewed distribution has a fat left tail where declines extend far beyond what you would expect for a normally distributed data set.

The chart below illustrates this. Out of 22,013 trading days going back to 1928, just 47.8% of days resulted in negative outcomes while 52.2% resulted in positive outcomes. This makes sense given the generally upward trajectory of equity markets over that period. If we sort each day's return into buckets, we start to see asymmetries develop. For instance, there were 10,973 days on which markets moved higher or lower by by 0.5%, just 48.4% of which were lower. The majority of 0.5 to 1% and 1 to 2% changes were to the positive side as well. The distribution changes once we look at the 2% and over bucket. Out of 1485 days with "extreme" returns, the majority (51.9%) of changes were declines of 2% or greater rather than rises of +2% or greater.

Figure: Distribution of daily changes in the S&P 500 index going back to 1928

Financial economists have a number of hypothesis for negative skewness. One theory blames leverage, whereby a drop in a firm's equity price raises its leverage, or the amount of debt it uses to finance itself. This makes an investment in the company more risky and leads to higher volatility of its shares. Conversely, when a stock rises, its leverage decreases, making the shares less risky. For that reason, rises in equities are tame while falls are wild. While an attractive theory, data shows that as stock prices decline, all-equity financed companies experience jumps in volatility of the same magnitude as leveraged companies, indicating that leverage is not a good explanation for a pattern of negative skewness.

Another explanation is the existence of "volatility feedback." When important news arrives, this signals that market volatility has increased. If the news is good, investor jubilation will be partially offset by an increase in wariness over volatility, the final change in share price being smaller than it would otherwise have been. When the news is bad, disappointment will be reinforced by this wariness, amplifying the decline.

Other theories blame short sale constraints for the asymmetry. If bearish investors are restricted from expressing their pessimism, they will be forced to the sidelines and their information will not be fully incorporated into prices. When the bulls start to bail out of equities, the bearish group becomes the marginal buyer, at which point bearish information is finally "discovered" by the market, the result being large price declines.

Putting the reasons aside, behavioral finance types have some interesting things to say about how investors perceive skewness. According to prospect theory, investors are not perfectly rational decision makers. To begin with, returns are not appraised in a symmetrical manner; a 5% loss hurts investors more than a 5% gain feels good. Next, investors overweight unlikely events and underweight average ones. Given these two quirks, investors may prefer positively skewed assets (like government bonds), which have far fewer large declines than normally skewed assets, as this distribution reduces the potential for psychological damage. The possibility of large lottery-like returns, the odds of which investors overweight relative to the true odds of a positive payout, also drive preferences for positive skew assets. Negatively skewed assets like equity ETFs, which expose investors to tortuous drops while not offering much potential for large melt-ups, are to be avoided.

Put differently, positive skew is a feature that investors will pay to own. Negative skew is a "bad" and people need to be compensated for enduring it.

If you buy this theory, then in order to coax investors into holding negatively skewed assets like stocks, sellers need to offer buyers a higher expected return. The presence of this carrot could be one of the reasons why equities tend to outperform bonds over time. For equity owners who are suffering through the current downturn, here's the upshot: negative skew events like the current one, while stressful, may be the price you have to pay in order to harvest the superior returns provided by stocks over the long term.

How many bullets does the Bank of Canada have left in its chamber?

It's been a while since I blogged about Canadian monetary policy, but Luke Kawa's recent tweet on the topic of Canada's effective lower bound got me thinking.

BoC has referred to 0.25% as its "effective lower bound" -- Shenfeld suggested that any lower, BoC thinks there'll be problems in money mkts

— Luke Kawa (@LJKawa) August 4, 2015

Luke is referring here to CIBC chief economist Avery Shenfeld's recent missive on how the Bank of Canada might react if the Canadian economy's losing streak were to continue. According to Shenfeld, the Bank of Canada has one final quarter point cut left in its quiver—from 0.5% to 0.25%. Should the bleeding continue, Governor Stephen Poloz can then turn to forward guidance and only when that has been exhausted will quantitative easing become a possibility.

Really? The Bank of Canada can't go below 0.25%? Has Shenfeld not been following what has been occurring outside Canada's borders over the last twelve months? Sweden's central bank, the Riksbank, has cut its repo rate to -0.35% while the European Central Bank has ratcheted its deposit rate down to -0.2%. The Swiss National Bank is targeting an overnight interest rate of -0.75%, down from 0% the prior year, at the same time that the Danmarks Nationalbank currently maintains a certificate of deposit rate of -0.75%. I've been covering this stuff pretty exhaustively here, here, here, here, and here.

After digging a bit further, I was surprised to find that the sort of interest rate emasculation implied in Shenfeld's piece is endemic here in Canada. David Rosenberg of Gluskin Sheff, for instance, recently said that Poloz has "just one bullet left in the chamber" while the FP's John Schmuel wonders what will happen if the Bank of Canada is forced to use its "last remaining lifeline and cut its rate to zero." The Bank of Canada is also a transgressor in spreading the meme: on its FAQ, the Bank says that the overnight rate's lowest possible level—its effective lower bound—is 0.25%.

One reason the faux 0.25% lower bound continues to circulate in the public discourse is the somewhat lazy reliance commentators have on the Bank of Canada's credit crisis playbook as a model for how low rates can go. In addition to implementing forward guidance during the crisis, the Bank reduced the overnight rate to 0.25% by flooding the system with excess balances. But this playbook has gone stale. As I've already pointed out, a number of European central banks have demonstrated the possibility of going below zero. A Bank of Canada deposit rate cut to as deep as, say, -0.50%, combined with an overnight target of -0.25, effectively buys Poloz three more 25 basis point interest rate cuts, not just one.

Ask folks why Canadian markets can't bear negative interest rates and there's typically a lot of arm-waving and mumbling about money markets. Case in point is Shenfeld on the +0.25% level: "In the Canadian money market structure that’s as low as she gets, and effectively represents the zero lower bound for monetary policy." I'm not aware of a single Canadian fixed income product that can't bear slightly negative interest rates. Would maple syrup commercial paper markets come to a standstill if the Bank of Canada cut rates to -0.25%? Would the market for Gordie Howe bonds collapse? While no doubt a nuisance, the transition to negative rates has been managed by money markets in Denmark, Sweden, Switzerland, and the rest of Europe without major mishap. There's simply no justification for Canadian exceptionalism.

While slightly negative rates won't cause structural problems in money markets, deeply negative rates would certainly be problematic. Send rates low enough and bank runs will begin as people cash in their negative-yielding money market instruments for paper dollars. At some point the banking system would cease to exist. But this doesn't occur at Shenfeld's so-called 0.25% lower bound, nor at -0.75%. Thanks to the carrying costs of bulky banknotes, it probably only starts to be a problem somewhere between -1.0% to -3.0%. The existence of a wide safe zone before hitting those levels gives the Bank of Canada a lot more lifelines than just one.

The last reason for the circulation of a false lower bound in Canadian monetary policy discussion is vested interests. I doubt that Canada's big banks are fond of incurring the frictional costs associated with transitioning to a negative rate world. Better to "wipe out" that possibility from the Overton Window and push something less-threatening like forward guidance.

Let me be clear that I have no specific insight into whether the Bank of Canada should be loosening or not. What is important is that the Bank has flexibility to the downside should it decide that easing be necessary. Breathing space is important because pound-for-pound, actual interest rate cuts are always better than unconventional policies like forward guidance—the promise to keep interest rates too low in the future—or quantitative easing. A move to -0.15% or -0.25%, should it be necessary, represents a continuation of the Bank of Canada's decades' long method of implementing conventional monetary policy via direct interest rate adjustments. It's not fancy, but it has been in place for a long time and everyone pretty much gets it by now. Central bank guidance, on the other hand, is complicated and suffers from the fact that the public can never be sure that a three-year promise initiated by a Conservative-appointed governor will stay in place should an NDP-appointed governor take his place. As for quantitative easing, it doesn't even work in theory, as pointed out by none other than Ben Bernanke. (Or see how New Zealand's cashing up the system had no influence on prices)

Incidentally, if Canada were to suffer a broader shock than the current one and the Bank of Canada found it necessary to go deep into negative territory, say -6%, there are all sorts of ways it can go about doing so without causing stress in money markets. In fact, economist & blogger Miles Kimball recently visited the Bank of Canada to explain how to go about implementing extremely low rates without igniting a run into paper dollars, or what he refers to as massive paper storage. I've written about some "lite" ways to go about doing so as well.

Interestingly, Kimball writes that the Bank of Canada already has an “Effective Lower Bound” working group that is focused on "exploring the possibilities for negative interest rate policy in the next recession." So while the public discourse on Canadian monetary policy seems to have settled on the "one remaining lifeline" view, it appears that internally that is not the case—the Bank of Canada knows that it has much more up its sleeve.

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Various charts: