Interest rate policy: the issues and where key macroeconomists stand on them

A new paper by Thomas I. Palley calls into question hopes that negative interest rates will be beneficial to the economy (see this post).

Key impacts of interest rate reductions include:

1) reduced interest-payments for asset-holders, leading to lower consumption spending

2) reductions in financing costs for purchases of car and other vehicles and homes

3) increases in the value of existing financial assets, such as bonds, sometimes leading to a relaxation of liquidity constraints that limit spending

4) purported positive effects on business investment

5) rising debt burdens in the longer run, assuming lower rates stimulate borrowing

6) negative effects on currency values that occur as asset holders shift the compositions of their portfolios toward higher-return assets denominated in other currencies

Keynesians–especially British Keynesians and those in the Cambridge tradition–have traditionally discounted most expansionary effects, especially number (4). They have also noted many disadvantages of a stop-and-go policy in which central banks actively manipulate the interest rate, including destabilizing effects of various kinds. Stock-flow-consistent modelers such as the late Wynne Godley and chartalists (MMTers) such as L. Randall Wray have emphasized effect (1), which works in a perverse direction. Keynesians in SFC traditions (including Godley, Wray, and many others) recognize the importance of impact (5). Modelers in many non-neoclassical traditions—such as the Kalecki-Steindl school—have long left interest rates out of their models of net business investment, avoiding the empirically dubious effect (4).

In addition to arguing on the grounds of a lack of effectiveness, the Hyman P. Minsky, Nicholas Kaldor, and others in the Keynesian and post-Keynesian school were among the classic writers deriding interest rate movements as destabilizing in various ways.

Palley in his paper emphasizes the nonexpansionary effects (along with other drawbacks of rate cuts). To put in context for those following posts on this blog related to macro models and CDFs, I will provide a word on how these efforts fit into the schema above. Models that I have been working on avoid assuming effect (4). A recent working paper, leading to ongoing work with Tai Young-Taft, includes all of the other effects (1 through 3 and 5), though it does not model depreciation of the durable goods mentioned in (2). Simpler versions of the model leave some effects out, and do not purport to be comprehensive.

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