Excerpt from the WSJ, 1/22/2015 \"The ECB plans to purchase more than €1 trillio
ID: 1167849 • Letter: E
Question
Excerpt from the WSJ, 1/22/2015
"The ECB plans to purchase more than €1 trillion ($1.157 trillion) in public and private sector bonds by the fall of 2016, a landmark decision aimed at combating stagnation and ultralow inflation in a region that has emerged as a top risk to the global economic recovery."
It seems like the macroeconomic 'buzzword' Quantitative Easing (QE) has returned - the Fed in the US conducted three rounds of QE with the third jokingly referred to as "QE infinity." As we know, the Fed is done with QE, at least for now. The ECB earlier this year announced their plans (as above) and Japan is in at least their second round of QE. In the first part of this problem, we are going to focus on Japan. Below is an excerpt from (here for article) the Guardian.
"The Bank of Japan’s most recent QE programme began in April 2013, when central bank boss Haruhiko Kuroda promised to unleash a massive QE programme worth $1.4tn (£923bn)."
From article: "While we remain sceptical of the ability of Japan to achieve 2% inflation over the next two years, governor Kuroda is at least stepping up the attack on deflation meaning that his chances of achieving some success have increased."
a) (5 points) Using the data in the table - the CPI from Japan, calculate the rate of inflation in Japan a year leading up to April 2013. That is, calculate the inflation rate between March 2012 to March 2013. Assuming that nominal interest rates in Japan are zero (they are!), what is the ex-post real rate of interest from March 2012 to March 2013? In this case, are consumers more willing to save or spend? Explain.
b) (5 points) We now are going to examine whether or not this QE appears to be working in Japan. Calculate the rate of inflation from April 2013 (the first month of QE) to April 2014. Assuming again that nominal interest rates are zero during this period, what is the ex-post real interest rate now? In this case, are consumers more willing to save or spend? Explain. Does it appear that this round of QE is working in Japan, why or why not?
c) (5 points) We now update to see if QE is still working. Calculate the rate of inflation from May 2014 to May 2015. Assuming again that nominal interest rates are zero during this period, what is the ex-post real interest rate now? In this case, are consumers more willing to save or spend? Explain. Does it appear that QE in Japan is still working? Why or why not?
We now move on to the US. You will need to use the following links to answer this question.
Nominal one year rates (i) Click Here https://research.stlouisfed.org/fred2/data/GS1.txt
Price index CPI (P) Click Here https://research.stlouisfed.org/fred2/data/CPIAUCSL.txt
Expected Inflation Click Here https://research.stlouisfed.org/fred2/data/MICH.txt
In this part of question 2, we are going to compare the most recent one year real interest rates in the US - both ex-ante and ex-post.
A couple notes are in order.
i) Expected inflation data is one year hence - so for example, expected inflation for the period from July 2010 to July 2011 is given in July 2010 and if you view the data, the expected inflation during this time is 2.7% = ?e.
ii) To calculate the actual rate of inflation, for example, during the July 2010 to July 2011 period you need to take the percent change in P = %? P. Using the CPI data, we have the
price index equaling 217.7 in 7/2010 (beginning of August given the end of month data) and 225.6 in 7/2011 (end of July, 2011). Note, this is a 12 month period. The actual rate of inflation during this time is 3.63% = ?
iii) When using the one year nominal interest rate to calculate the all important real rate(s) of interest we need to be careful. For example, using the same one year time period (July 2010 - July 2011) we simply use the one year rate given as of July 2010. Think of buying the bond in July 2010, putting it in a safety deposit box (or under your mattress, a coffee can, etc.) and then cashing it in when it matures in July 2011 (you get your principal times whatever the nominal interest rate is). In viewing the data, the one year rate in July 2010 is 0.29%. So clearly (and by design of the Fed), both the ex-ante and ex-post real rates are negative during this period and differ because expected inflation was not equal to actual inflation.
d) (5 points) Using the most recent data, calculate the ex-post real interest rate.
e) (5 points) Given the most recent data, what is the ex-ante one year real rate of interest?
f) (5 points) Assuming that the Fed feels that there is still significant slack in the economy, which real interest rate does the Fed want the consumer to consider, the ex-post or the ex-ante? Explain.
g) (10 points) From a macroeconomic perspective, why is deflation so bad? Please refer to consumer behavior and the corresponding behavior of firms in a deflationary environment. Please explain completely.
h) (10 points)Now discuss the fact that persistent deflation is the central bank's worst nightmare Why is this environment such a nightmare for the central bank and monetary policy and why is persistent deflation such a nightmare? Explain using the Fisher equation for the real rate of interest and refer to both the ex-post and ex-ante real rate of interest.
Historical Consumer Price Index (CPI) for Japan (2010 to 2015) Last Update: August 28, 2015 Next Update: September 25, 2015 Start Year 2010 End Year 2015 Get Historical CPI Da Year janfeb mar apr may jun jul aug sep oct nov decann 2015 103.1 102.9 103.3 103.7 104 103.8 103.7 2014 100.7 100.7 101 103.1 103.5 103.4 103.4 103.6 103.9 103.6 103.2 103.3 102.7 2013 | 09.3 | 99.2 | 99.4 | 99.7 | 99.8 | 99.8 | 100 | 100.3 | 100 100.7| 100.7| 100.9 | 100.0 2012 99.6 99.8 100.3 100.4 100.1 99.6 99.3 99.499.6 99.6 99.2 99.3 99.7 2011 99.5 99.5 99.8 99.9 99.9 99.7 99.7 99.9 99.9 100 99.4 99.4 99.7 2010 | 100.1 | 100 100.3| 100.4 | 100.3| 100.1 | 99.5 | 99.7 | 99.9 100.2| 99.9 99.6 | 100 a) (5 points) Using the data in the table - the CPI from Japan, calculate the rate of inflation in Japan a year leading up to April 2013. That is, calculate the inflation rate between March 2012 to March 2013. Assuming that nominal interest rates in Japan are zero (they are!), what is the ex-post real rate of interest from March 2012 to March 2013? In this case, are consumers more willing to save or spend? Explain. b) (5 points) We now are going to examine whether or not this QE appears to be working in Japan. Calculate the rate of inflation from April 2013 (the first month of QE) to April 2014. Assuming again that nominal interest rates are zero during this period, what is the ex-post real interest rate now? In this case, are consumers more willing to save or spend? Explain. Does it appear that this round of QE is working in Japan, why or why not? c) (5 points) We now update to see if QE is still working. Calculate the rate of inflation from May 2014 to May 2015. Assuming again that nominal interest rates are zero during this period, what is the ex-post real interest rate now? In this case, are consumers more willing to save or spend? Explain Does it appear that QE in Japan is still working? Why or why not?Explanation / Answer
(a) the inflation rate for Japan between March 2012 and March 2013
will be = (99.4-100.3)/100.3 = -0.90 (as %)
the real interest will be nominal interest rate minus the inflation rate for a given period= 0- (-0.90) = 0.90
The consumers will save more rather than spend as the rate of return on their savings is positive.
(b) the inflation rate for Japan between April 2013 and April 2014
= (103.4-99.8)/99.8 =3.61 (as %)
the ex-post real interest will be nominal interest rate minus the inflation rate for a given period= 0- (3.61) = -3.61
The consumers will spend more rather than save as the rate of return on their savings is negative. A rational consumer will not invest his sum at negative interest rates. Quantitative easing refers to unconventional monetary policy in which a central bank buys government and other securities from the market in order to lower interest rates and increase money supply in the economy. The quantitative easing is working in this case as the inflation rate is going up.
(c) Inflation rate May 2014 to 2015,
=(104-103.5)/103.5=0.48
the ex-post real interest will be nominal interest rate minus the inflation rate for a given period= 0-0.48=-0.48
The process of quantitative easing is not working as the interest rate has gone back to the level of around 0. The ex-ante interest rates are positive and the saving option is better for the consumers.
(d)
(c) Inflation rate July 2014 to July 2015
=((238.099-237.596)/237.596)*100
=0.21
the ex-post real interest will be nominal interest rate minus the inflation rate for a given period= 0-0.21=-0.21
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