The Case For Negative Nominal Interest Rates As Presented At Jackson Hole
Posted: Sun Aug 28, 2016 11:57 am
The annual Jackson Hole federal economics conference has just ended and Marvin Goodfriend, a Friends of Allan Meltzer Professor of Economics at Carnegie Mellon's Tepper School of Business, presented a paper on the necessity of unencumbering the zero bound on interest rate policy:
"Reflecting the plausible pessimism that has been growing for some time, the zero bound
encumbers interest rate policy today because nominal market interest rates around the world
have drifted precipitously lower in the past two decades. For instance, average inflation-indexed
10-year bond rates in the developed world, and in the U.S. alone, have fallen steadily from 4
percent in the mid-1990s to around zero percent today. And with inflation stabilized at or below
2 percent and inflation expectations well-anchored, nominal bond yields have declined to historic
lows, too. Also at work depressing the long term nominal bond rate is the net compensation for
risk transfer (term premium) which has fallen from around 2 percent in the mid-1990s to near
zero today, as we shall see, plausibly reflecting the shift from cyclical inflation risk to cyclical
deflation risk.
The problem for monetary policy is that low long term nominal rates leave little or no
room for the usual cyclical fluctuations of short term nominal rates below long term nominal
rates over the business cycle. Moreover, the secular decline in long term nominal interest rates
reflects underlying factors likely to persist—low inflation expectations, downward pressure on
the intertemporal terms of trade, and downward pressure on the price of risk transfer in long
bonds. It is only a matter of time before another cyclical downturn calls for aggressive negative
nominal interest rate policy actions."
He speaks of the necessity to abolish paper currency, introduce a flexible deposit price of paper currency, or a third method which I do not fully understand to accomplish his goal:
"With these advantages in mind, the paper describes three methods by which the zero
bound on interest rate policy can be unencumbered completely. The three methods in turn would:
i) abolish paper currency; ii) introduce a market-determined flexible deposit price of paper
currency; and iii) provide electronic currency (to pay or charge interest) at par with deposits,
with or without the provision of paper currency as in (ii) above."
He concludes his remarks with:
"With inflation credibly under control, the public could safely hold longer term nominal
bonds to minimize its exposure to negative short term interest rates. Thus, we can imagine a
mutually reinforcing equilibrium in which the public extends the maturity of its savings and the
central bank with the public’s support feels free to pursue negative nominal interest rate policy
whenever required to perpetuate full employment and price stability. The idea of negative
nominal interest rates takes some getting used to, but it should be possible to make the public
aware eventually that such flexibility in short term interest rates is well worth it to provide better
employment security and more secure lifetime savings."
In his address he also sites the previous unpegging of our gold standard as a success story, which makes me think that if this policy were pursued there would be much, much more upside in bonds to be had while, at the same time, reducing the value of our money through this "flexible market_determined deposit price of paper currency."
https://www.kansascityfed.org/~/media/f ... .pdf?la=en
Note: Jim Rickards brought this to my attention with one of his tweets this morning.
"Reflecting the plausible pessimism that has been growing for some time, the zero bound
encumbers interest rate policy today because nominal market interest rates around the world
have drifted precipitously lower in the past two decades. For instance, average inflation-indexed
10-year bond rates in the developed world, and in the U.S. alone, have fallen steadily from 4
percent in the mid-1990s to around zero percent today. And with inflation stabilized at or below
2 percent and inflation expectations well-anchored, nominal bond yields have declined to historic
lows, too. Also at work depressing the long term nominal bond rate is the net compensation for
risk transfer (term premium) which has fallen from around 2 percent in the mid-1990s to near
zero today, as we shall see, plausibly reflecting the shift from cyclical inflation risk to cyclical
deflation risk.
The problem for monetary policy is that low long term nominal rates leave little or no
room for the usual cyclical fluctuations of short term nominal rates below long term nominal
rates over the business cycle. Moreover, the secular decline in long term nominal interest rates
reflects underlying factors likely to persist—low inflation expectations, downward pressure on
the intertemporal terms of trade, and downward pressure on the price of risk transfer in long
bonds. It is only a matter of time before another cyclical downturn calls for aggressive negative
nominal interest rate policy actions."
He speaks of the necessity to abolish paper currency, introduce a flexible deposit price of paper currency, or a third method which I do not fully understand to accomplish his goal:
"With these advantages in mind, the paper describes three methods by which the zero
bound on interest rate policy can be unencumbered completely. The three methods in turn would:
i) abolish paper currency; ii) introduce a market-determined flexible deposit price of paper
currency; and iii) provide electronic currency (to pay or charge interest) at par with deposits,
with or without the provision of paper currency as in (ii) above."
He concludes his remarks with:
"With inflation credibly under control, the public could safely hold longer term nominal
bonds to minimize its exposure to negative short term interest rates. Thus, we can imagine a
mutually reinforcing equilibrium in which the public extends the maturity of its savings and the
central bank with the public’s support feels free to pursue negative nominal interest rate policy
whenever required to perpetuate full employment and price stability. The idea of negative
nominal interest rates takes some getting used to, but it should be possible to make the public
aware eventually that such flexibility in short term interest rates is well worth it to provide better
employment security and more secure lifetime savings."
In his address he also sites the previous unpegging of our gold standard as a success story, which makes me think that if this policy were pursued there would be much, much more upside in bonds to be had while, at the same time, reducing the value of our money through this "flexible market_determined deposit price of paper currency."
https://www.kansascityfed.org/~/media/f ... .pdf?la=en
Note: Jim Rickards brought this to my attention with one of his tweets this morning.
