Matt Rognlie on negative interest rates

What Lower Bound? Monetary Policy with Negative Interest Rates (Job Market Paper)

Abstract:  Policymakers and academics have long maintained that nominal interest rates face a zero lower bound (ZLB), which can only be breached through major institutional changes like the elimination or taxation of paper currency.  Recently, several central banks have set interest rates as low as -0.75% without any such changes, suggesting that, in practice, money demand remains finite even at negative nominal rates. I study optimal monetary policy in this new environment, exploring the central tradeoff: negative rates help stabilize aggregate demand, but at the cost of an inefficient subsidy to paper currency. Near 0%, the first side of this tradeoff dominates, and negative rates are generically optimal whenever output averages below its efficient level. In a benchmark scenario, breaking the ZLB with negative rates is sufficient to undo most welfare losses relative to the first best. More generally, the gains from negative rates depend inversely on the level and elasticity of currency demand. Credible commitment by the central bank is essential to implementing optimal policy, which backloads the most negative rates. My results imply that the option to set negative nominal rates lowers the optimal long-run inflation target, and that abolishing paper currency is only optimal when currency demand is highly elastic.

The paper is here, and it contains many new analytical points.  As you would expect from Matt, it is also extremely well-written.  Here are previous MR posts related to Matt Rognlie.

Here Eric Lonergan criticizes Swiss negative interest rates.  On the blog of Miles Kimball, you will find many arguments for negative nominal interest rates, and also the abolition of currency, another topic covered by Matt in his paper.

By the way, here is the latest on Swiss bond rates, negative even at ten years out.


Why are owners of capital so pessimistic? Several days ago Cowen's friend Peter Thiel had a guest op/ed in the NYT in which he laments the choice made in the 1980s to abandon nuclear power, a choice he attributes to Three Mile Island and a movie (The China Syndrome). More likely is that owners of capital don't want to invest in nuclear power plants - they are very, very, very expensive and the returns aren't so great. Just like they don't want to invest in productive capital or public infrastructure. Sure, owners of capital will speculate on leveraged buyouts, currency trading, and real estate, but not on what makes an economy more productive and increases wages and long-term economic growth. While Rognlie matches wits with Thomas Piketty (interesting I suppose in debates over political economy), the world's economy languishes because owners of capital are so pessimistic. Why?

I don't expect an answer to my question, but John Taylor's explanation is that the Fed's policy of low interest rates, quantitative easing, etc. is putting a ceiling on long term interest rates, analogous to rent control which reduces the supply of rental housing. The result of low interest rates, Taylor says, is a “decline in credit availability [that] reduces aggregate demand, which tends to increase unemployment, a classic unintended consequence.” Since markets are perfect, the government must be to blame; hence, it doesn't occur to Taylor that markets are reflecting lack of demand for capital because investors are pessimistic.

The market wants to have a debt deflation. The central banks are trying to prevent it.

That is a weird argument. Rent control reduces development yields and subsidizes renter entrenchment. Open market purchases subsidizes borrowers and increases risk adjusted return on equity. They have opposite effects. Maybe Taylor meant something else and simply used a clumsy analogy, but that argument makes no sense as written.

Actually, it really makes no sense because Taylor assumes that OPM purchases in the treasury/notes/bills markets results in corresponding declines in credit rates. If you relax that assumption, then you could jump some logic hurdles like the Neo-Fisherians. Strange argument, indeed. Did he ever clarify it?

You can have my currency when you pry it from my cold, dead hands. Seriously, I think there would be a mass revolt if Kimball's idea of essentially charging a fee to use cash were implemented.

And that's why inflation is important.

'essentially charging a fee to use cash'

Do you ever shop at any store that accepts credit cards? In that case, you are paying a fee to use cash.

Not a sign of mass revolt anywhere to be seen, by the way.

...Recently, several central banks have set interest rates as low as -0.75% without any such changes, suggesting that, in practice, money demand remains finite even at negative nominal rates....

There's a big difference between cash money that I own outright and credit money that I have to repay to the bank.

The Swiss yield curve has entered lunacy land.

Wouldn't it be cheaper to just buy a safe deposit box and stuff it with 1000 CHF notes?

You could stuff tens of millions of francs in cash in a safe deposit box and it would cost you only 500 francs per year, far less than the tens of thousands of francs you would lose by buying a note with a 1% negative yield.

I understand there's a transaction cost here but this is insane.

Yes; the transaction costs are what's keeping this charade going.

In the UK banks are withdrawing from the safety deposit box business because it's uneconomic. I wonder how large the costs really are, maybe more than you'd think. I also wonder how easy it is to get CHF1k notes in quantity. You'd expect them to trade at a premium today. Lower denomination notes are quite bulky.

Central Banks better be careful with this negative interest rate stuff. They might be able to get away with -0.5% or -0.75% for a while, but if they push it too far, even the least financially savvy among us will realize that it will be worth the inconvenience to hoard money in means other than in fiat currency stored at a bank that will be deducted each month. Weimar Germany showed perfectly well that the government does not decide what money is—society decides what money is.

There are many alternatives to fiat currency in a bank: fiat currency under the mattress protected by a house guard dog, fiat currency in a tin can in the backyard protected by a guard dog, fiat currency in a safety deposit box, bitcoin, GOLD.

Policy analysts talk blithely about "abolishing" paper currency—HA! And you thought gun control was a touchy issue! Wait until the guvment starts coming for people's cash in their wallets. "Out of my cold, dead hands!" they will reply. Mass protests. Revolution.

I have a novel approach that I haven't heard anywhere before. Have the central bank issue dual currencies, one inflationary, one price-stable. Risk-averse, politically powerful, high saving groups are still free to hoard the latter at zero rates.

The kicker is that Congress sets the aggregate income tax rate, but the Fed can adjust the differential between the two currencies. During contractionary periods, they can raise relative taxes rates on the deflationary currency, until enough business and investment is redominated in inflation-bucks. This even helps fix the sticky wage problem, during recessions laid off workers can take a job paying inflato-bucks until they get their reserve wage back in safe-bucks.

Here's an idea - do the negative interest rate, do the tax on cash and institute a small transfer per capita to every adult electronically, to compensate for what would be a normal household's typical extra outflow due to the negative interest rate. The large users of cash still get pinched. The average household's situation remains the same, more or less. Heavy users of electronic payment methods benefit slightly.

nice post. that's inflation is more important

Comments for this post are closed