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Measuring risk

How much risk is in the economy? It depends what you mean by risk. If you want to know, roughly, the level of risk that businesses cannot honor their debts, then you want to look at the risk premium. The risk premium quantifies the differences in the yields of bonds in different risk categories. This risk premium is not constant through time: It changes as the overall economy goes through its ups and downs that impact businesses. Here we look at the difference in yields between Moody’s Aaa and Baa corporate bonds. It is clearly visible that much risk was present in the 1920s, 1930s, and 1940s and also in several of the recent recessions, in particular the previous one. Lately, this risk has largely been vanishing, as corroborated by the St Louis Fed Financial Stress Index©.

How this graph was created: Search for “Moody’s” and select the Aaa rate at a monthly frequency (for a longer sample). Then you add the Baa series and apply transformation “b-a.”

Suggested by Christian Zimmermann

View on FRED, series used in this post: AAA, BAA

Negative interest rates

On June 11, 2014, the European Central Bank broke new ground by lowering one of its key policy rates below zero. That is, the rate in question (the rate on the deposit facility available overnight to European banks) is now negative. While a policy rate can in principle be set at any level, it is more difficult to think about a market interest rate that would be negative. Indeed, one would always earn a higher return by simply holding on to one’s money rather than depositing it for a negative return. Yet, the graph shows two rates—one in Switzerland and one in Denmark—that are in negative territory.

What’s special about Switzerland and (more recently) Denmark? The Swiss franc has a reputation as a very stable currency and hence acts as a refuge currency when trouble is brewing elsewhere. Given that Switzerland is a small economy, when the Swiss franc is high in demand worldwide, investors are willing to accept negative rates if they think their own local currencies may depreciate. This happened when the fixed exchange rate regime of Bretton Woods was in jeopardy, later when European currencies were volatile, and recently when the European Monetary Union went through some pains and few non-euro currency options were available. One of those currencies was the Danish krone, which then also found itself in the role of a refuge currency.

How this graph was created: Search for “immediate rates,” select the relevant countries, and click on the “Add to graph” button.

Suggested by Christian Zimmermann

View on FRED, series used in this post: IRSTCI01CHM156N, IRSTCI01DKM156N

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