Facebook Twitter LinkedIn

Matt Yglesias has a very interesting new post:

Something really weird is happening in Europe. Interest rates on a range of debt “” mostly government bonds from countries like Denmark, Switzerland, and Germany but also corporate bonds from NestlÃ© and, briefly, Shell “” have gone negative. And not just negative in fancy inflation-adjusted terms like US government debt. It’s just negative. As in you give the German government some euros, and over time the German government gives you back less money than you gave it. In my experience, ordinary people are not especially excited about this. But among finance and economic types, I promise you that it’s a huge deal “” the economics equivalent of stumbling into a huge scientific discovery entirely by accident. Indeed, the interest rate situation in Europe is so strange that until quite recently, it was thought to be entirely impossible. There was a lot of economic theory built around the problem of the Zero Lower Bound “” the impossibility of sustained negative interest rates. Some economists wanted to eliminate paper money to eliminate the lower bound problem. Paul Krugman wrote a lot of columns about it. One of them said “the zero lower bound isn’t a theory, it’s a fact, and it’s a fact that we’ve been facing for five years now.” And yet it seems the impossible has happened.

If I wanted to quibble I’d say Yglesias slightly exaggerates the element of surprise here. Some of us knew that US T-bill yields fell a couple of basis points below zero around 1939-40. But on the bigger issue he’s right. I never would have expected negative 0.75% nominal interest rates. In retrospect, I underestimated the cost of storing large quantities of cash. I’d guess it’s much higher than 100 years ago, when banks routinely dealt with large quantities of gold, and currency notes with denominations as large as $100,000.

And most other economists were even further off base. Indeed back in 2009 I used the cost of storing cash as an argument in favor of negative IOR, and some Keynesians disagreed with me. They said negative IOR would merely cause ERs to transform into safety deposit boxes full of currency. I said the American public didn’t want to store trillions of dollars in currency and coins. There’d be at least a modest hot potato effect.

As Matt points out, the key takeaway is that the US was never at the zero bound:

The big one is that central banks, including the United States’, may want to consider being bolder with their interest rate moves. For years now, the Federal Reserve’s position has been that it “can’t” cut interest rates any lower because of the zero bound. Instead, it’s tried various things around communications and quantitative easing. But maybe interest rates could go lower? Unlike the European Central Bank, the Federal Reserve pays a small positive interest rate on excess reserves. Fed officials normally say this doesn’t make a difference in practice, but it looks like negative rates on excess reserves may be the key to negative bond rates.

It’s no longer an issue of “just 25 basis points.” German 5-year bond yields are currently negative, which is considerably lower than the 0.60% that they bottomed out at in America. If we were never at the zero bound, then the foes of market monetarism have pretty much lost their only good argument for fiscal stimulus.

Now for the curve ball. I am not saying the Fed should have tried to replicate the negative 5-year bond yields of Germany. I view negative long term bond yields not as an expansionary monetary policy, but rather as a sign of failure. Never reason from a bond yield. A truly expansionary monetary policy might well have raised long-term bond yields. My claim is different. I’m saying that for those who do think nominal interest rates are a good indicator of the stance of monetary policy, it’s now clear that the Fed could have cut rates much more sharply.

But that’s not why I believe the Fed was never out of ammunition. I relied on an entirely different reasoning process. I noticed that Ben Bernanke never once suggested that the Fed had run out of paper and green ink.

Facebook Twitter LinkedIn

Tags:

This entry was posted on February 26th, 2015 and is filed under Monetary Theory. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



