Scott Sumner  

Market monetarism continues to make progress

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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.


Comments and Sharing






COMMENTS (7 to date)
ThomasH writes:

I'm happy to see that the Fed is open to using another instrument in pursuing its objectives but:

a) I don't see why negative interest rates are especially MM and

b) the availability of the instrument will not necessarily help if the constraint on the Fed is something else, such as an inflation rate ceiling or political pressure, from the permahawk/goldbug wing of (practically the whole) Republican party.

TallDave writes:

Lots of things we take for granted once seemed impractical. Who would pay for a radio signal addressed to no one?

E. Harding writes:

Early October 2008.

Scott Sumner writes:

Thomas, I agree that negative IOR is not a specifically MM idea, but it is an idea that we were the first to promote. Back in 2009 I struggled to get others interested in the idea.

I don't think the GOP is having much influence on Fed policy. They WANT to raise rates.

E. Harding, Thanks, I fixed it.

Michael Byrnes writes:

On the topic of whether MM is gaining steam, here is Tim Duy on an interesting speech from Fed governor Lael Brainard:


I think Yellen wants to raise interest rates. I think Fischer wants to raise rates. I think both believe the downward pressure on inflation due to labor market slack is minimal, and the Phillips Curve will soon assert itself. I think both do not find the risks as asymmetric as does Brainard. I think they believe the risk of inflation is actually quite high. Or, probably more accurately, that the risk of destabilizing inflation expectations is quite high.

I think that Brainard knows this. I think that this speech is a very deliberate action by Brainard to let Yellen and Fischer know that she will not got quietly into the night if they push forward with their plans.

eric writes:

So, if IOER is negative what happens? If excess
reserves are drawn down, what supports the assets
on the Fed's balance sheet? What does the banking
system do with the funds and how does that impact
the economy?

bill writes:

I hope they would use negative IOR. But as I'm sure you'd admit, I don't think it has much credibility. They may eventually use a negative IOR but they will always use too little, too late. The fact that we still aren't back to 0% IOR (the "normal" for 95 years), is something that will affect market reactions and expectations for several years.

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