Market monetarism continues to make progress
By Scott Sumner
One of the earliest ideas to come out of market monetarism was the proposal for negative interest rates on reserves (negative IOR). I mentioned this idea in a couple papers published in early 2009, and the New York Fed discussed it soon after. As with other market monetarist ideas, it was initially viewed as being impractical. I wish I could tell you how many debates I had with commenters telling me that it could not possibly work. The Financial Times occasionally published pieces claiming that it would even be contractionary.
And then something interesting happened—several European countries started adopting negative interest rates on reserves. First Sweden, and more recently Switzerland, Denmark and even (slightly) the ECB. Early this year there was concern that Denmark might be forced to revalue its currency upward, but it never happened.
And now Bloomberg reports that the Fed seems willing to utilize negative IOR in the next recession, after earlier viewing my idea as being impractical:
Federal Reserve officials now seem open to deploying negative interest rates to combat the next serious recession even though they rejected that option during the darkest days of the financial crisis in 2009 and 2010.
“Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” said William Dudley, the president of the New York Fed, in an interview on CNBC on Friday.
The Fed under former chairman Ben Bernanke considered using negative rates during the financial crisis, but rejected the idea.
“We decided — even during the period where the economy was doing the poorest and we were pretty far from our objectives — not to move to negative interest rates because of some concern that the costs might outweigh the benefits,” said Dudley.
Bernanke told Bloomberg Radio last week he didn’t deploy negative rates because he was “afraid” zero interest rates would have adverse effects on money markets funds — a concern they wouldn’t be able to recover management fees — and the federal-funds market might not work. Staff work told him the benefits were not great.
But events in Europe over the past few years have changed his mind. In Europe, the European Central Bank, the Swiss National Bank and the central banks of Denmark and Sweden have deployed negative rates to some small degree.
“We see now in the past few years that it has been made to work in some European countries,” he said.
“So I would think that in a future episode that the Fed would consider it,” he said. He said it wouldn’t be a “panacea,” but it would be additional support.
In fact, Narayana Kocherlakota, the dovish president of the Minneapolis Fed, projected negative rates in his latest forecast of the path of interest rates released last month.
Kocherlakota said he was willing to push rates down to give a boost to the labor market, which he said has stagnated after a strong 2014.
In early October
2009 2008, the Fed first adopted a positive interest rate on reserves, and then raised it twice in November. Just imagine that instead the Fed had cut IOR to negative 0.75% in their September 16, 2008 meeting, two days after Lehman failed. (At the time the fed funds target was positive 2%.) Perhaps TARP would not have even been necessary.
Now the Fed needs to reconsider their views on level targeting, which is even more powerful than negative IOR during a recession. And then NGDP level targeting.
PS. Tyler Cowen finds this comment from Olivier Blanchard:
“I thought that the zero interest rate, the decrease in the price of oil, the depreciation of the euro, the pause in fiscal consolidation, would help more than they have”, he said.
I hope that readers familiar with “never reason from a price change” were not surprised.
PPS. My blogging may be slow as I have a cold today, and am also traveling. I do promise that I will eventually provide detailed comments on Bernanke’s new book.