OSO tacks another tack: What’s up?
Summary: Real negative interest rates rob people. The US has endured
five periods of real negative interest rates since 1954 – two of which
have occurred since 2002. It was the 2002-2005 period of negative
interest rates which saw the expansion of the housing bubble. Now that
it has popped, is the current bout of negative interest rates going to
limit the recession or will it make it worse?
While I agree that the subprime crisis and the credit crunch that has
followed has a deflationary effect, I also believe that high oil prices
and a low US Dollar have created an inflationary environment as well.
More than that, I believe that the net effect of these crises will end
up on the inflationary side of things. Moreover, I can see a
stagflationary environment (5% inflation plus 5% unemployment)
developing over the course of the year.
It seems reasonably clear from this latter graph that Greenspan’s rate
cuts after the tech boom went way too far. The early 80s rate cuts and
the early 90s rate cuts were far more staggered, while the 2001 cuts
were like jumping off a cliff. It could be argued, therefore, that
America’s monetary policy, post-2001, has been dangerous, imbalanced
and, well, incompetent. Not only was inflation allowed to exceed
interest rates, but it created a bubble that, when popped, has resulted
in yet another period of negative real saving.
In other words, what caused the problem is being used to solve it.
The US economy has only diced with negative real rates five times since
1954: 1957-1958, 1974-1980, 1994, 2002-2005 and 2008 (the last one is
ongoing). The fact that the last two have occurred so quickly is what is
Let me explain again what the problem with negative interest rates are:
They punish people for saving while rewarding them for spending; they
punish people for lending and reward people for borrowing; they punish
people who are judicious and reward those who are careless. In short,
negative real interest rates are a recipe for economic disaster.
This, in turn, is one reason why I have argued for years that central
banks, including the Fed, should focus clearly on reducing inflation.
Employment, which is of vital importance to society, and businesses, who
make the decision to employ people, both need economic growth. But
economic growth, to be sustainable over the long term, needs to have low
inflation and positive real interest rates.