For some unexplained reason, Japan's central bank, the BOJ, did not cut interest rates on bank reserves, which are already negative. They talked as if they were going to do so. This lack of added stimulus has the markets down and bond prices up.

Draghi in the Eurozone has already decided to buy more sovereign bonds, and while that increases bank reserves and the money supply (but only if the banks lend the money), investors pay the tax for negative yield. And with a scarcity of good sovereign bonds worldwide, mainly as collateral for derivatives, negative yields are driven down simply by central banks taking them out of circulation, making them even more scarce. So, in Japan and in the Eurozone bond yields are turning negative.

We know that prices for Japanese bonds went up and yields went down, and that is no surprise. People must understand the distinction between negative rates on excess reserves, and negative rates on bonds. Negative rates on excess reserves, according to Scott Sumner, are expansionary. An argument can be made that they are not massively expansionary. Bonds with negative yields can be expansionary, if central banks buy them, but only if the excess reserves are loaned out. And don't forget the scarcity of bonds in the first place.

But obviously traders did not take well to the shock of having this stimulus not added. Scott Sumner is right that negative IOR is expansionary of the money supply. The BOJ believes negative IOR is expansionary.

But, negative bond yields are a different animal. Negative bond yields in a deflationary environment could confirm deflationary expectations. But Japanese bonds do fund the government, as the BOJ can buy and sell government bonds at negative yield.

I am not a fan of negative IOR, when real helicopter money is a far superior option and Scott Sumner says Nominal GDP Targeting (NGDP Targeting) is superior as well. But at zero lower bound, negative IOR is certainly better than living with negative bond rates. One wonders if the BOJ and Draghi at the ECB are engaged in some sort of economic fraud, a scam to fund the government in the face of economic weakness, and deflationary expectations with negative rate bonds!

We hope that is not the case, and we know that the BOJ still plans to reach their inflation target of 2 percent in the 2017/2018 time frame. Certainly Nominal GDP has improved some in Japan over the years, since the Great Recession crash of 2008. 

Since Japanese banks hold most of the Japanese treasury bonds, why would they prefer to hold onto negative rate bonds and cash reserves rather than lending the reserves into the economy to overcome the negative bond rates they must pay out?

You have to wonder what is going on in Japan and in the Eurozone, and hope the sickness doesn't find its way to the USA.