With most economic variables, I think we make too big a deal about crossing zero on the number line. I don’t feel great if real GDP’s growing at 0.2% and horrified if it’s at -0.2%. Deflation with price growth at -0.5% isn’t terribly worse than disinflation with price growth at +0.5%.
But with nominal interest rates, crossing zero is a big deal. Negative interest rate are a true oddity, if not a pathology. Lenders paying borrowers is problematic, and not just because those of us who write about the threat of the zero lower bound now have to add an asterisk every time we say “nominal rates cannot, of course, go below zero.”
They can and they do, as Neil Irwin points out in the NYT. Central banks have set rates below zero in the eurozone, Sweden, and Switzerland (see figure). As Irwin reports, Fed chair Yellen, who recently oversaw and supported a small rate increase, is not inclined to go to the negative place, but you can be sure Fed economists are noodling over what this all means (apparently, they’re not even sure if negative rates are legal here).
On that, read Irwin, who raises many reasons why this particular crossing of the river zero is so tricky. To the extent that negative rates work like a tax on banks who store reserves at the central bank, they’ll try to pass the charge onto their customers. And why not just sit on cash if depositing it (or lending it through a bond) costs you? Leaving money in the bank is a lot less enticing when you have to pay to do so.
Which is, of course, the point. Central banks are exploring whether negative rates are a form of monetary stimulus that will generate more demand in persistently weak economies where austerity hamstrings fiscal policy and the ZLB does the same to monetary policy.
Maybe negative rates will help, though I’ve not seen evidence to support that yet. What we have seen: bank stocks got whacked in countries that are trying this. Trust me, I don’t lose sleep worrying about the profitability of the financial sector, but it is “systemically important.”
What I think is more important to recognize here is that central banks using negative rates are implicitly admitting that they’ve lost control of inflation.
The negative rate that central banks would much prefer to be operative is the real rate, i.e., the nominal rate minus inflation. But both because of their own hawkery on this front—great devotion to anchoring price growth at a low inflation target of 2%–along with global deflationary trends in commodities, they’ve been missing their inflation targets on the downside for years. And that’s propped up real rates relative to where they’d be in more normal inflationary times.
The Yellen Fed tells us such deflationary forces as the strong dollar and cheap oil are transitory; such thinking certainly loomed large in their recent rate liftoff. But I’m wondering if that word—transitory—means what they think it means. The idea that the Phillips Curve is merely on vacation as opposed to out of commission may be the wrong foundation for contemporary monetary policy.
Moreover, look at the figure. Who wouldn’t invest in dollar-based securities given those global interest rate dynamics? The fact that other central bank rates are moving in the opposite direction to our own is sure to further strengthen, not weaken, the dollar, thus continuing to dampen inflation and prolonging that aspect of the problem. Increased capital flows from weakening China to the U.S. further exacerbate the problem.
OK, if I’m so smart, what would I do? Well, not raise our own Fed funds rate. Not be wound up about nascent inflationary pressures about to materialize out of the deflationary fog. Nudge Congress to consider fiscal policy, like a deep infrastructure dive, to help generate more demand.
If I wanted to get outside the box, I’d tell the staff to put aside the negative rate mishegoss and think about what a mainstreamer like Lord Adair Turner is doing talking about “helicopter money,” or money creation that finances fiscal deficits. And he’s not alone.
I’m not saying this is a good idea, especially since I fear any spending priorities would have to go through Congress (“Hey, let’s print free money and give it to Congress! What could go wrong?”). In essence, helicopter money for fiscal policy is analogous to executive orders and rule changes for regulatory policy. Congress is dysfunctional, therefore the president must take over regulatory policy and the Fed, fiscal policy.
Not the way to run an $18 trillion economy, I agree. But I suspect many of us can wrap our heads around it easier than negative rates.