Not to be negative, but…a critical comment on negative interest rates.

February 15th, 2016 at 2:25 pm

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).

Source: NYT

Source: NYT

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.

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9 comments in reply to "Not to be negative, but…a critical comment on negative interest rates."

  1. JD Phillips LCSW says:

    The best soft landing for capitalism is Firewall Economics. A central premise of FE is to treat different markets differently. Why now low interest rates for things like a young person buying a modest home, and higher rates for bankers leveraging derivatives? Strong gov help for necessities, and hands off capitalism for markets where nobody starves if the house falls in. And bring public banking back to the US.

  2. Shaun Peterson says:

    I don’t understand why monetizing or “helicopter money” is so reviled and feared. There is historical precedent where it actually worked. I think it’s just every low information participant just knows Weimar style inflation is around the corner when we do this. Also, my FB feed would be filled to the brim with Ron Paul memes more than ever before. I just simply don’t know if I could tolerate that.

  3. Smith says:

    There is one presidential candidate advocating fiscal stimulus, but unfortunately he claims all his programs are paid for by new taxes and closing tax loopholes. No deficit, thus no relief for the current situation. However, a story prominently displayed on the website says it would in fact cost much more and create a huge deficit. If only this were true. Unfortunately the paper’s political reporting on Sanders has been accused of bias, as acknowledged by public editor going back to Sep 9, 2015.
    “Here’s my take: The Times has not ignored Mr. Sanders’s campaign, but it hasn’t always taken it very seriously. The tone of some stories is regrettably dismissive, even mocking at times. Some of that is focused on the candidate’s age, appearance and style, rather than what he has to say.”
    But cheer up, if you believe that taxing the rich to pay for college, healthcare and infrastructure, can create more demand than waiting for yacht sales to nudge the economy, then there still is a way out.

    Word of caution, in a functioning global economy, if ever it returned, oil prices would quickly double, (two years ago over $100/barrel, currently around $30) annualized monthly inflation (despite 2% core) would spike to 5% and Republicans would howl. Democrats are not prepared to deal with that, raising rates could easily send us into a recession (also count on big business to raise prices in spiral fashion even while cars and housing tank).

  4. dwb says:

    None of the above. I’d say that the inflation target should be between 2-3% (really, a band). Even better, the target should be the nominal growth rate of the economy (5%).

  5. lilnev says:

    Helicopter money is, alas, fiscal policy. And we can’t have nice things. The R’s decided that a long time ago, and the D’s don’t seem to be interested in challenging the myth, “deficits are always bad.” Any monetary policy is second best.

  6. Peter K. says:

    Helicopter money or Corbyn’s People’s QE sidesteps the deficit hawks. The central bank can judge how much is necessary for their inflation/unemployment targets. Then Congress and the President can direct the spending. Aid to the states? Clean energy? The first advanced nation to try this out will escape the SecStags.

  7. David C says:

    The negative interest rates in Switzerland are a bit of a special case. The goal isn’t really managing domestic demand. Unemployment is very low, for example.

    The Swiss have seen a huge strengthening of their currency. Many people see the Swiss Franc as a safe haven in an uncertain world. The strong currency is really hurting their export and tourism industries. The Swiss National Bank instituted the negative interest rates at the same time they removed the peg of the Franc vs. the Euro, in an attempt to keep the exchange rate down.

  8. Nathanael Nerode says:

    “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.”

    Oh, Lord Adair Turner is calling for it now? Good for him. I always thought he was a more openminded thinker than the average economics politician.

    Those of us who were slightly less mainstream were advocating very loudly for this since 2008. But of course the Very Serious People — including all too many supposedly left-wing economists — did not listen to us, and were even scolds about the very idea. I still don’t understand why.

    There’s some persistent bizarre fear of money creation to fund fiscal deficits, even though it’s known to work for dealing with “general glut” recessions and is the primary recommendation of Keynes for such situations.

    I can’t figure out where this fear came from. I understand why the *right-wingers* who want hard money are afraid of it, but I don’t understand why easy-money advocates are afraid of it.