For those who viewed negative interest rates as a bridge too far
for central banks, it might be time to think again.
In the U.S., the Federal Reserve — supported both implicitly and
explicitly by the Treasury — is on track to backstop virtually every private,
state and city credit in the economy. Many other governments have felt
compelled to take similar steps. A once-in-a-century (we hope) crisis calls for
massive government intervention, but does that have to mean dispensing with
market-based allocation mechanisms?
Blanket debt guarantees are a great device if one believes that
recent market stress was just a short-term liquidity crunch, soon to be
alleviated by a strong sustained post-COVID-19 recovery. But what if the rapid
recovery fails to materialize? What if, as one suspects, it takes years for the
U.S. and global economy to claw back to 2019 levels? If so, there is little hope
that all businesses will remain viable, or that every state and local
government will remain solvent.
A better bet is that nothing will be the same. Wealth will be
destroyed on a catastrophic scale, and policymakers will need to find a way to
ensure that, at least in some cases, creditors take part of the hit, a process
that will play out over years of negotiation and litigation. For bankruptcy
lawyers and lobbyists, it will be a bonanza, part of which will come from
pressing taxpayers to honor bailout guarantees. Such a scenario would be an
unholy mess.
Now, imagine that, rather than shoring up markets solely via
guarantees, the Fed could push most short-term interest rates across the
economy to near or below zero. Europe and Japan already have tiptoed into
negative rate territory. Suppose central banks pushed back against today’s
flight into government debt by going further, cutting short-term policy rates
to, say, minus 3% or lower.
For starters, just like cuts in the good old days of positive
interest rates, negative rates would lift many firms, states and cities from
default. If done correctly — and recent empirical evidence increasingly
supports this — negative rates would operate similarly to normal monetary
policy, boosting aggregate demand and raising employment. So, before carrying
out debt-restructuring surgery on everything, wouldn’t it better to try a dose
of normal monetary stimulus?
A few important steps are required to make deep negative rates feasible
and effective. The most important, which no central bank (including the
European Central Bank) has yet taken, is to preclude large-scale hoarding of
cash by financial firms, pension funds, and insurance companies. Various
combinations of regulation, a time-varying fee for large-scale re-deposits of
cash at the central bank and phasing out large-denomination banknotes should do
the trick.
It is not rocket science (or should I say virology?). With
large-scale cash hoarding taken off the table, the issue of pass-through of
negative rates to bank depositors — the most sensible concern — would be
eliminated. Even without preventing wholesale hoarding (which is risky and
expensive), European banks have increasingly been able to pass on negative
rates to large depositors. And governments would not be giving up much by
shielding small depositors entirely from negative interest rates. Again, given
adequate time and planning, doing this is straightforward.
Blizzard of objections
Negative interest rates have elicited a blizzard of objections.
Most, however, are either fuzzy-headed or easily addressed, as I discuss in my
2016 book on the past, present, and future of currency, as well as
in related writings. There, I also explain why one should not think of
“alternative monetary instruments” such as quantitative easing and helicopter
money as forms of fiscal policy. While a fiscal response is necessary, monetary
policy is also very much needed. Only monetary policy addresses credit
throughout the economy. Until inflation and real interest rates rise from the
grave, only a policy of effective deep negative interest rates can do the job.
A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic. Even with negative rates, many countries would still need a debt moratorium. But a weaker dollar, stronger global growth, and a reduction in capital flight would help, especially when it comes to the larger emerging markets.
Bank profits
Tragically, when the Federal Reserve conducted its 2019 review
of policy instruments, discussion of how to implement deep negative rates was
effectively taken off the table, forcing the Fed’s hand in the pandemic.
Influential bank lobbyists hate negative rates, even though they need not
undermine bank profits if done correctly. The economics profession, mesmerized
by interesting counterintuitive results that arise in economies where there
really is a zero bound on interest rates, must share some of the blame.
Emergency implementation of deeply negative interest rates would
not solve all of today’s problems. But adopting such a policy would be a start.
If, as seems increasingly likely, equilibrium real interest rates are set to be
lower than ever over the next few years, it is time for central banks and
governments to give the idea a long, hard, and urgent look.
Kenneth Rogoff, a former chief economist of
the IMF, is professor of economics and public policy at Harvard University.
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