I have in these pages criticized on more than one occasion the unconventional monetary policies (UMPs) of advanced economy central banks, policies which may be a cure worse than the disease, emanating from the global financial crisis. The latest avatar of UMPs is the policy of negative nominal interest rates being pursued by several major central banks, crashing through the notional barrier of the zero lower bound (ZLB).
Negative nominal interest rates not only put enormous strain on the banking and financial system, they penalize ordinary savers while enriching (at least temporarily) those who invest in bubble-prone assets.
Meanwhile, excess liquidity builds up in the system, no one is investing, and an exit from UMPs and a return to conventional monetary policy is pushed ever further into the distant future.
In this context, it is disappointing, but perhaps to be expected, that orthodox economic commentators are rushing in to defend the new orthodoxy of advanced economy central banks and a set of policies which would have been considered bizarre and unwise a mere decade ago, just as the Great Moderation was about to come crashing down.
Consider two recent contributions to the debate, both published in the Financial Times, and both of which fail to make a convincing case for negative rates. Writing recently, Kenneth Rogoff, former chief economist of the International Monetary Fund and Harvard economics professor, attempts to debunk straw-man arguments rather than tackle the real issues.
Thus, he suggests, there is nothing “unnatural” about negative rates, which simply represents a modern form of debasing the currency, as used to be possible during the time of metallic currency and before the advent of paper currency. But this is besides the point: What is at issue is whether negative rates make good economic sense, not a semantic debate on whether they are natural or unnatural.
Rogoff also makes the peculiar argument that since other policies intended to boost aggregate demand, such as protectionism and reversing structural reform, are clearly bad, negative rates might be a sensible policy option. But this leaves unexplored alternative monetary policy and exchange rate arrangements which might be superior to zero rates and is thoroughly unconvincing.
Even more disappointing, perhaps, is Martin Wolf, chief economics commentator for the Financial Times, who, on matters related for instance to trade policy, is usually on the mark. Thus, he dismisses as a “howl of pain” legitimate criticisms of negative rates, the implication being that such criticisms might be self-serving.
But this again fails to do justice to the substance of the underlying critique.
What is more, Wolf’s response to considered criticism is weak, to put it mildly. Thus, he writes, “the impact of low rates, even negative nominal rates, on the business models of financial intermediaries can be dealt with only by changing those models or eliminating the need for such low rates altogether”. Really? Perhaps he would like to suggest another business model for banks other than the spread between borrowing and lending rates? As for eliminating the need for low rates, that is surely what is at issue and cannot be assumed away.
Wolf also reveals a woeful ignorance of the current macroeconomic scenario when he asserts that low rates, which make borrowing cheaper, “should stimulate investment and so increase productivity growth”. But the fact that this has not happened, and that excess liquidity is being hoarded or parked in bubble-prone assets, not productively invested, is at the crux of the critique of the zero or negative rates to begin with.
So what is the way forward?
As economist James W. Dean and I argued recently in this newspaper (see “Central Bankers Need New Tools”, 6 October), we need a match between policy objectives and policy tools. In line with the celebrated Tinbergen principle of the theory of economic policy, multiple objectives will require multiple tools. At present, the policy interest rate is being tasked not only with achieving an inflation target, but also with trying to undo the structural damage caused by the great financial crisis, in a world in which primary structural reforms and countercyclical fiscal policy are notable by their absence. This is a recipe for disaster.
What is needed is some combination of short-run fiscal policy, to revive aggregate demand, and, more importantly, fundamental regulatory reforms which work on the supply side.
The first set of policies would work to bring output and employment back towards their long run or natural levels; the second set of policies would work towards boosting the long-run level of output itself by increasing productivity growth, at present anaemic in the US and other advanced economies.
We can have a serious debate about the mix of fiscal and structural policies that are needed, and the correct balance between short run and long run. What is not serious is to assert that negative rates are a cure-all.
Robert Mundell has famously said: money is a bubble. In other words, fiat currency relies on trust. A protracted period of negative rates is likely to imperil this trust.
Every fortnight, In The Margins explores the intersection of economics, politics and public policy to help cast light on current affairs.
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