In my September 5, 2022 post, “How a Toolkit Lacking a Full Strength Negative Interest Rate Option Led to the Current Inflationary Surge,” I write:
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Thinking falsely that it couldn’t fall back on negative rates, the Fed was too slow and timid in raising rates for fear that it didn’t have the firepower to quickly reverse a recession if it went too far in raising rates.
In his Project Syndicate op-ed “When the Fed Stops Trying,” Brad DeLong confirms that this concern is on his mind, and indicates he thinks it has been on the mind of policy-makers in the Fed. Here are some key quotations from that piece, separated by added bullets:
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Biden’s team knew that if the reopening inflation shock was too large, it could easily trigger an overreaction from the US Federal Reserve. That, eventually, would put America back in a semi-depressed or depressed state of secular stagnation, with little policy traction to respond to the next crisis or to promote a recovery.
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The situation was thus analogous to Odysseus sailing between Scylla (a multi-headed monster) and Charybdis (a massive whirlpool). The Biden administration could either not try to navigate the strait at all (the first mistake), or it could try its luck with Scylla (secular stagnation) and Charybdis (stagflation).
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Not without reason, financial markets seem to be betting that the Fed is about to make mistake number two: pursuing policies that will likely drag the US back toward secular stagnation. If past is prologue, we eventually will return to a scenario in which monetary policy is stuck at the zero lower bound. The economy may suffer another lost half-decade of growth, and socially and politically destabilizing inequalities will become even more pronounced.
In the last passage, Brad makes it clear the “secular stagnation” means being stuck at the zero lower bound. But of course, there is no zero lower bound. The idea that interest rates cannot be cut below zero, or cannot be cut very far below zero, is inside-the-box thinking—and the box is made of only flimsy material. The more I have worked on the details of how to best implement deep negative rates, the clearer it becomes that it is an available policy option. You can see the details in the resources laid out in my bibliographic post, “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” (You can always get there by clicking on the “NEG.RATES” button at the top of this blog.)
Also, despite West Virginia v. EPA, the authority of the Fed (a) to buy and sell Treasuries and (b) over its own reserve accounts needed to implement negative interest rate policy are so clearly authorized by statute, I believe the Fed, under current law, has the authority to implement deep negative rates along the lines of “How the Fed Could Use Capped Reserves and a Negative Reverse Repo Rate Instead of Negative Interest on Reserves.” (I am currently writing an article with a law professor, intended for a law review, making this case.)
Note that, as things stand, the likely timeline for needing negative rates allows plenty of time to lay out a monetary policy strategy including negative interest rates as part of the toolkit before we will need to actually implement negative rates.
Right now, one of the main objections people might make to negative interest rate policy is “You have to be kidding! How could you be talking about negative interest rates when inflation is so high. We need big interest rate hikes, not negative rates.” That is true as far as it goes, but I am arguing that the Fed’s slowness to raise rates is partly due to its fear that it doesn’t have the tools to deal with a serious recession. That raises the cost of raising rates too much—by a lot. The Fed will be scared to with inflation vigorously and promptly unless it also has the tools to deal with deflation. Imagine driving on a mountain road with a sheer drop to your right. Wouldn’t that increase the danger that you would hew to close to the middle of the road and collide with oncoming traffic? Or to take Brad’s analogy, if we know we can disarm and defang Scylla with negative interest rate policy, then we can steer far away from Charybdis.
