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The world of NIRP

We have entered the era of negative interest rates, with over $11 trillion in sovereign bonds now paying such rates. This situation results in part from deliberate actions of central banks around the world to deal with deflationary conditions. Tom Palley criticizes negative interest rate policy (NIRP) as a macro policy in a new paper (download link) at his website.  He argues that overall, negative rates will not stimulate the economy and are likely to prolong a boom-bust cycle based on the growth of the financial sector.

First, one minor quibble: Palley does not mention consumer credit for expenditures on nondurable goods or vehicles, two key areas where reduced interest rates are likely to have a expansionary impact. Macroeconomically, Palley’s position is largely based on an overall assessment of the likely slopes of investment and saving functions based on Keynesian theory. He notes that interest rate reductions are likely to have little effect on business investment when returns at the margin are near zero. (This page provides a summary of purported monetary policy effects and various economists’ positions on them.)

Palley stands in opposition to a more Wicksellian approach that sees the key macro problem as blocked interest rate adjustment. Modern adherents of this latter view include Paul Krugman, the economist and New York Times columnist. who has emphasized the zero lower bound on interest rates as a special situation making for deficient-demand stagnation.

Palley also mentions the effects of the policies on asset markets and asset holders, including insurance companies and pension funds. He notes that the general run of investors will be forced into either instruments with negative returns or riskier, bubble-prone investments. He sees some stimulation of real estate and presumably construction, which is likely in his view to lead inevitably to a future crash.

Overall, Palley lists a number of worrisome impacts of leaning toward monetary rather than fiscal stimulus when interest rates are already extremely low.

I am strongly in agreement with the notion that fiscal stimulus is preferable to additional monetary-policy stimulus. I also feel—much in the vein of Luigi Pasinetti’s “fair real interest rate”—that retail savers with discretionary funds should have some non-fragile options whose rates of return keep up to some extent with inflation. Some of these have traditionally included money market mutual funds, bank certificates of deposit, and so on. A related need is for an overall retirement system to cover all of the non-super-wealthy.

On a related note, Gary Dymski of  Leeds University Business School lamented “the fragilization of money” among other things in a presentation at the Allied Social Sciences Association meetings this past January (just before what turned out to be a busy and interesting semester). Dymski pointed out that a heavy reliance on uninsured institutions is among the effects of a system in which shadow banking has greatly increased in relative importance since Hyman P. Minsky first began to develop his theory of financial fragility. These developments undermine the ability of quasi-monies that pay interest to ensure that savers never incur capital losses.

Palley’s paper points to the need for some attention to the fiscal side at a time of declining deficits and points out numerous harms of relying on policies that stimulate the economy through effects on asset prices, including the formation of bubbles. To my mind, though, interest rate cuts are likely to stimulate employment and growth in the near term. Also, the Yellen and the Fed’s policy-setting committee should be given credit for having only certain policy instruments under their control at a time when policymakers around the world have been overly inclined toward adopting austerity policies. On the other hand, the presentation based on work by Dymski and his coauthors* pointed to the need for stable investment vehicles for the middle class and ways for the less-well-off to accumulate some assets.

*Annina Kaltenbrunner, Susan Ozawa Perez, and Mimoza Shabani

Vyankatesh
July 30th, 2016 at 7:17 am

Do read my blog on the topic of – Understanding Negative Interest Rates. NIRP is here to stay for the next two years (atleast !)

August 8th, 2016 at 5:09 am

Thank you for the useful link.

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