Monday, February 1, 2016

Comments on "The Potential Power of Negative Nominal Interest Rates"

Here are some comments on Narayana Kocherlakota's "The Potential Power of Negative Nominal Interest Rates."

Negative nominal interest rates allow a central bank to achieve lower real interest rates, without raising inflation expectations.
So, negative nominal interest rates lower inflation expectations. Agreed.

...a negative nominal interest rate gives more policy space to the central bank. It has much the same benefits as raising the inflation target, without the costs associated with higher inflation.
As I pointed out here, Narayana is actually a neo-Fisherian; he just hasn't come to terms with it. He understands that, on average, a higher inflation target requires a higher nominal interest rate.

Here’s the wrong way to communicate: keep saying that negative is a purely emergency setting that will be abandoned shortly. The impact of policy depends on the expected path of interest rates over the medium and longer term. The central bank’s communication means that its expanded policy space will have little influence on those medium and longer term expectations. Note that even if the central bank actually keeps rates negative for many years, this ongoing communication will systematically rob the policy of its effectiveness (as well as hurting central bank credibility).
Actually, more correctly stated, the impact of policy depends on how the public understands the central bank's policy rule. So, the central bank might want the public to understand that negative nominal interest rates won't happen often (it's an emergency setting, or it depends on very low real interest rates, etc.). That's quite legitimate, and just gives everyone a better understanding of what the central bank is up to.

Here’s the right way to communicate: keep saying that all available tools, including negative interest rates, will be used as is needed to return employment and inflation to desirable levels as rapidly as possible.
That's the crux of the problem. Negative interest rates will in fact not lead to a return of employment and inflation to desirable levels in a rapid fashion, under some conditions. As I pointed out in my last post, the Swedish Riksbank, the central bank of Denmark, the Swiss National Bank, and the ECB, have all gone negative, and they have not been returning inflation rapidly to their 2% targets - in same cases they are getting further away, and it's not hard to see why.


  1. Stephen, regarding negative rates, do you agree with Scott Sumner here that Yellen's testimony was "face palm" worthy?

    Also, I'm curious if you agree with him on this statement (from his prior post):

    "The empirical evidence in favor of sticky wages is simply overwhelming. It’s just about the only thing in macroeconomics that we can be certain is true."

    One last (unrelated) thing: your view of intertemporal budget constraints? Specifically David Glasner's take in this latest.

    1. No idea what Sumner is so excited about - on both counts. With respect to #2, we can observe that wages are "sticky" in the sense that wages of individuals in the same jobs change infrequently. But that need not tell you anything about how monetary policy works.

  2. "He understands that, on average, a higher inflation target requires a higher nominal interest rate."

    Nobody cares about long-run averages. This is economics and not maths, this is a social science, this is about how people behave. And the main assumption of your neo-Fisherian model, namely that monetary policy impacts only nominal rates and not the real rate, is utterly preposterous.

    1. Well, that's a collection of errors and contradictions!

      "Nobody cares about long-run averages." Of course we do, in many ways. In this instance, any monetary policy rule aimed at achieving some inflation target (on average - that's what it's all about) will imply that the nominal interest rate is higher, on average.

      "This is economics and not maths..." That's like saying: "this is medicine, not chemistry." Mathematicians gave us some wonderful tools, and we would be stupid not to use them in economics, which is a quantitative social science.

      "this is about how people behave." Agreed, but that doesn't mean that mathematics can't or shouldn't be used to understand how we behave.

      "...your neo-Fisherian model" There is no neo-Fisherian model that I thought up. All the conventional macro models people use are in fact neo-Fisherian.

      "monetary policy impacts only nominal rates" Who said that? It is true, however, that essentially all central banks target some overnight nominal interest rate. That's just what they do. Impacts are another thing altogether.

      "not the real rate" didn't say that either. There can be short run, and long run effects of monetary policy on the real rate.