Low oil prices were supposed to be a big boost for the world economy; but it didn’t happen. Maury Obstfeld, my long-time textbook co-author and now chief economist at the IMF, offers an interesting argument about why: he suggests that it’s because of the zero lower bound. Falling oil leads to falling inflation expectations, and since interest rates can’t fall, real rates go up, hurting recovery.

Matt O’Brien is skeptical, and so am I — even though I am very much in favor of rethinking our usual assumptions when the economy is at the ZLB.

First, a priori, falling oil prices shouldn’t affect expectations for the rate of inflation of non-oil goods and services, or at least it’s not obvious that it should — and that’s the inflation rate that should matter for investment. Still, you could argue that oil is in fact driving those expectations, whether it should or not. What Matt does is question whether correlation is causation.

I’d make another point: even using market expectations, real interest rates have in fact gone down, not up, in the face of falling oil prices:

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How is this possible, given the zero lower bound? It’s all about the term structure: long-term rates aren’t at zero, although they’re at least somewhat supported by the floor on short-term rates. And as it turns out, during the recent oil crash long-term rates fell enough to more than offset the decline in expected inflation.

Of course, Maury could be right in an other things equal sense. But my guess is that the oil-price disappointment comes less from expectational channels than from two facts: oil is now a big driver of investment, via shale, and oil exporters are actually cash-constrained these days, with an arguably *higher* marginal propensity to spend than oil consumers.

Anyway, interesting stuff.