Think of low interest rates as an outcome, not a tool
By Scott Sumner
Tyler Cowen has a Bloomberg column discussing negative interest rates in the Eurozone. As with virtually all discussion of negative rates, the article doesn’t quite get to the essence of the issue:
Most economists and central bankers view negative interest rates as an acceptable tool of macroeconomic management. Maybe so. But in an era when trust, including trust among nations, is much lower than previously thought, it probably isn’t a good idea to place a punishing new tax on the German national virtue of saving. Central bankers must also be sensitive to public relations.
Here Tyler is viewing negative rates as a policy tool. That’s not entirely unjustified, as negative interest on bank reserves (IOR) is in fact an important policy tool. But it also misses something important.
Think of the following scenario. A central bank enacts a contractionary monetary policy, setting interest rates above the Wicksellian equilibrium level. This describes ECB policy during 2008-13, when nominal short-term interest rates were consistently positive (well above the zero bound), and excessively high relative to the equilibrium rate. This tight money policy reduced NGDP growth, which drove the equilibrium rate into negative territory. Anxious to avoid a major depression, the ECB then pushes then policy rate into negative territory, and also adopted a program of “QE”.
Do you see the problem here? The negative rate is in one sense an equilibrium outcome of a longstanding tight money policy (think negative long term bond yields), and in another sense an expansionary policy aimed at boosting inflation (think negative IOR). It’s both. Most discussion of this issue focuses only on the role of negative rates as a policy tool, which is actually the least important dimension of the issue.
To his credit, Tyler goes beyond the usual analysis, and eventually does get to the essence of the issue:
So if a policy of negative interest rates is just a Band-Aid, it is one that should be ripped off. And if monetary policy is insufficiently expansionary, that is going to require an increase in the ECB’s inflation target, or a move to nominal GDP targeting, not a jerry-rigged tax on deposits.
Bingo! I wish Tyler had provided much more of this, a much deeper look at how the eurozone can exit from negative rates. The only solution available to the ECB is to adopt a more expansionary monetary policy regime. Tinkering with the tools is not enough. Negative IOR is not enough.
The article also needs more discussion of the irony that the same German savers who are outraged by negative rates are also the single most powerful political force in Europe against a more sensible (i.e. more expansionary) monetary policy. I’m not blaming them; if even economists are confused then how can I expect average people to figure all this out? Nonetheless, Germans tend to oppose a more expansionary policy target that would push the equilibrium rate above zero, and thus allow for the policy rate to also rise above zero.
BTW, even if you reject my “market monetarist” analysis, and take the standard Keynesian view that tight fiscal policy is the problem, it is still conservatives in Germany who are most opposed to a solution for low interest rates. More than any other country in Europe, Germany has created the monetary and fiscal policy environment that enables negative interest rates.
In fairness, other countries are not blame free. Bad supply side policies in southern Europe are a drag on eurozone RGDP growth, and this tends to reduce the equilibrium real interest rate in the eurozone. And part of the cause may be exogenous factors such as demographics, for which no one is to blame.
I would also quibble with Tyler’s use of the term “insufficiently expansionary”. I understand why he uses this term; my claim that eurozone policy is contractionary goes against common sense, and would turn off readers that might otherwise be persuadable. But at some point the economics profession needs to take a hard look in the mirror and confront the fact that 99% of what’s been written over the past 12 years about the “stance” of monetary policy in Europe, Japan and America is utter nonsense, with no theoretical basis at all. I know that sounds harsh, but it is unfortunately true. The emperor has no clothes.