Contrasting views on negative rates

By two former central bankers.

Narayana Kocherlakota writes:

So, going negative is daring but appropriate monetary policy.   But it is a sign of a terrible policy failure by fiscal policymakers.

The reason that the FOMC has to go negative is because the natural real rate of interest r* (defined to be the real interest rate consistent with the FOMC’s mandated inflation and employment goals) is so low.   The low natural real interest rate is a signal that households and businesses around the world desperately want to buy and hold debt issued by the US government.   (Yes, there is already a lot of that debt out there – but its high price is a clear signal that still more should be issued.)  The US government should be issuing that debt that the public wants so desperately and using the proceeds to undertake investments of social value.

But maybe there are no such investments?  That’s a tough argument to sustain quantitatively.  The current market real interest rate – which I would argue is actually above the natural real rate r* – is about 1% out to thirty years.  This low natural real rate represents an incredible opportunity for the US. We can afford to do more to ensure that all of our cities have safe water for our children to drink.  We can afford to do more to ensure that our nuclear power plants won’t spring leaks.  We can afford to do more to ensure that our bridges won’t collapse under commuters.

These opportunities barely scratch the surface.  With a 30-year r* below 1%, our government can afford to make progress on a myriad of social problems.  It is choosing not to.

If the government issued more debt and undertook these opportunities, it would push up r*.  That would make life easier for monetary policymakers, because they could achieve their mandated objectives with higher nominal interest rates. But, more importantly, the change in fiscal policy would make life a lot better for all of us.

William Poole writes:

It won’t work. Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved.

Part of the impetus behind a central bank’s negative interest-rate policy is a desire to devalue the currency. With lower market interest rates, holders of euros, for example, may sell them to flee to countries with higher interest rates—driving down the euro’s exchange rate, boosting European exports and growth. But it is impossible for every country in the world to depreciate its currency relative to others. If the European Central Bank hopes to force euro depreciation against the yen and the Bank of Japan hopes to force yen depreciation against the euro, one or both of the central banks will fail.

Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. In the U.S., Congress should force the Federal Reserve to come clean about why growth has been so slow. The forthcoming congressional monetary policy oversight hearings—Feb. 10 for the House Financial Services Committee and Feb. 11 for the Senate Banking Committee—are the right place to explore what is wrong with the U.S. economy.

These committees ought to insist that the Fed, with its large and expert staff, present relevant studies by mid-June, in time for the annual oversight hearings in July. At the July hearings, the Fed can discuss its research. Academic and other experts can offer their analysis of the Fed’s findings. Instead of vague Fed statements about “headwinds,” the nation deserves solid empirical work on the problem.

Note, however, that both appeal to monetary policy to correct fiscal/structural failures! NK, for example, did much better in a previous post:

The Committee needs to change its basic policy framework.  Monetary policy is not about targeting the level and volatility of interest rates. The FOMC needs to have a framework in which the fed funds rate (and its other tools) are much more responsive to its medium-term forecasts of inflation and employment shortfalls.  Markets would then have to adjust to the possibility that interest rates might have to change rapidly, at any time and in either direction, if the FOMC believes that change is necessary to achieve its macroeconomic objectives more rapidly.

One thought on “Contrasting views on negative rates

  1. Great information here. However, the near misses in the quotes after all of this time has passed since the crisis point to our doom, monetarily, economically and politically for the loner term, a fate I had hoped to avoid. Thank you for not giving in or giving up.

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