Everything is back to being the same again
By Scott Sumner
The long dark age of vulgar Keynesianism is finally over. For 7 long years we’ve heard economists tell us that the laws of economics don’t apply at the zero bound. We are told that “everything is different” at the zero bound. Fiscal stimulus is not offset by monetary policy. Savings is a vice. Chinese trade surpluses cost jobs in the US economy, and paying people not to work for 99 weeks creates jobs. Aggregate demand curves slope upward. Payroll tax cuts are contractionary.
Now the zero bound is clearly gone. Let’s hope we can now return to the more sensible economics of the Great Moderation, when the New York Times wrote editorials calling for the abolition of the minimum wage, progressives advocated ending taxes on capital, Keynesians preferred monetary policy to fiscal policy, and Paul Krugman skewered protectionists on the left with “Pop Internationalism.” (And to be fair, when conservatives favored carbon taxes, and something very close to ObamaCare. And when conservatives didn’t think low rates meant easy money.)
Actually the zero bound has been gone for roughly a year, as this term actually refers to a situation where the Fed would like to cut interest rates, but is unable to do so because of the zero lower bound on nominal interest. The Fed had no desire to cut rates in 2015, even if they had been able to.
And ironically we now find out that all along the Fed was able to cut rates further; it simply didn’t understand that fact. In early 2009, I pointed out that central banks could pay negative interest on reserves. Initially people scoffed, but now many European countries have done so. Some argued the effect would be contractionary, but that’s not how European markets reacted to the news. Janet Yellen has indicated that negative IOR is an option in the next recession, and Ben Bernanke recently said the following:
I am not aware that ordinary checking accounts are paying negative rates. In the U.S., while I think negative rates are something the Fed will and probably should consider if the situation arises, I think there are limits to how negative rates could go and there are probably special features of the institutional environment in the United States which suggests they couldn’t go as negative here as they’ve gone in some European countries.
Does anyone doubt that “the situation” arose in early 2009 when I suggested negative IOR? I think Bernanke’s “will and probably should” statement is an implicit admission that the market monetarists were right and the Fed was wrong about negative IOR in 2009, just as in his memoir he admits that the Fed should have cut rates in September 2008, another key area where market monetarists disagreed with Fed policy.
Look for many more such admissions in the next few years.
The Fed’s decision to raise rates today was not unexpected, but the accompanying statement was rather disappointing. Every three months the Fed lowers its projections for future interest rates, gradually getting closer and closer to the market (and hence market monetarist) view of what is likely to happen. Why not just dispense with the forecasts entirely, and suggest that rate increases will depend entirely on progress toward its employment and inflation goals? And while they are at it, why not spell out those goals more precisely—exactly what are they trying to accomplish?
PS. Interestingly, the zero interest rate period lasted exactly 7 years, as rates first fell to the 0% to 0.25% range on December 16, 2008.