Zero Lower Bounds
These are the usual confused thoughts mostly stimulated by this excellent post by Simon Wren-Lewis
You really should click the link and read that post. I will try to summarise it.
First professor Wren-Lewis argues that monetary policy would not have offset less contractionary fiscal policy in the past 6 years, because short term safe nominal interest rates were stuck at the zero lower bound. Second, he argues that “For whatever reason (resistance to nominal wage cuts being the most obvious), inflation ceases to be a good indicator of underutilised resources when inflation starts off low and we have a major negative demand shock. ” So the not at all absolute zero lower bound on changes in nominal wages matters too.
The problem with the argument that nominal interest rates can’t be negative is that they are in Denmark and Switzerland. The logic was that interest rates on bank notes can’t be negative so negative interest rates on other assets can only equal the cost of holding wealth as cash in a safe. It turns out that these costs make negative interest rates possible. I don’t think this matters all that much. Cash in a box arbitrage still implies that there is a lower bound which is no higher than -1% per year (and might be lower but it exists). It also does not imply that looser fiscal policy would have been offset. If central bankers believe there is a zero lower bound and they are stuck at it(as the Federal Reserve board and the Bank of England did) will not raise interest rates above zero following any increase in aggregate demand. I don’t think recent market rates in Switzerland and Denmark refute the whole liquidity trap argument, but I do think that Krugman, Wren-Lewis and others (including your humble correspondent) have to consider the issue a lot more.
There is another, much less valid alleged zero lower bound. It is argued by, for example Jeremy Stein that safe interest rates of at least 2% are needed for banks to make profits without taking risky gambles. It is assumed that such gambles can’t be prevented by prudential regulation, so we have to pay them 2% protection money or else something might happen to the nice economy we have here. But the argument is that the cost of maturity transformation and such is 2% per year and it is just assumed that banks can’t (or won’t) charge depositers. That the worst deal a bank can offer me is the convenience of a checking account for zero interst. This is nonsense. I can’t get a deal that good from either of my two banks (including SunTrust which promised me exactly that deal, but has charged me fees). Banks can charge for the convenience. Italian banks have always done this. The zero lower bound on checking accounts is like the zero lower bound on nominal wage changes. It isn’t a no arbitrage condition, it is a norm. I can agree that bankers won’t drive off clients by charging fees because providing zero interest zero fee checking is temporarily unprofitable. But if it is agreed that they are willing to accept a little red ink, why is it assumed that they can’t be kept from making reckless gambles to avoid it ?
Finally the “resistance to nominal wage cuts”. This is very important. It is clearly not absolute. In US data there is a mass of wage changes of exactly zero, but there are also wage reductions. During the great depression, there were sharp reductions of nominal wages.
I think it is reasonable to assume that there are two key unemployment rates. The NAIRU and a higher rate needed before nominal wages are cut. Given differences in different local labor markets, downward nominal wage rigidity matters even when average wages are growing. The (not absolute) ZLB can bind for some occupations in some places even if average wages are increasing. Together these imply a region with a downward sloping long run Phillips curve. I am trying to summarize Akerlof, Dickens and Perry 1996 (warning pdf).
This would imply that a very low inflation target might cause permanently high unemployment (not high enough to break the downward nominal wage rigidity). It is clear that 2% inflation is consistent with low unemployment. It possible that a monetary authority which accepts inflation anywhere from 0% to 2% allows a permanently high unemployment.
During this last depression (which we laughingly call a recession) there were nominal wage cuts too, with people demoted or pushed into different job categories. Or replacement/ new hire people coming in for the same job at much lower wages. If you look only at hourly wages you get an inadequate picture.
lol on “Carol” calling this a depression. Simply lol. Go back to the 1930’s bitch and then tell me this is a “depression”.
Sorry, there is no such thing as a “zero lower bound”. It is a intellectual creation.
Sorry John:
Carol is exactly right on what happened to many people to which we still have not recovered. Mind your manners please.
John,
Somehow you have managed to exhibit the attitude of a sexist pig and an ignorance of monetary policy in one post of less than 40 words.
Your mother must be proud.
If negative interest rates ever happen to consumers I would open a stand alone safe deposit box business, as folks convert bank deposits to currency, they would need a safe place to store it. Unfortunatly the US only goes to $100 while there is a 500 Euro note and a 1000 swiss franc note. Unless you want to make currency depreciate a negative interest rate is not really doable.
And John let me double down on Run’s warning.
On my first read I just skipped over the ‘b’ word perhaps reading it as verb “don’t b-” rather than a noun as it clearly was.
It takes a lot to even get a comment deleted at AB. And only a handful of people have managed to get a permanent ban. Heck one prominent troll is working on his third life here after two ‘permanent’ bans . But even he knows where not to go on this kind of stuff. Don’t be ‘that guy’.
I think so as well Run and Bruce.
I like opinions that find a bit of truth in contradictory positions, so this seems very sensible. What was missing was consideration of why central banks do not act as if the actually HAVE inflation targets. They appear, rather to have interest rate ceiling targets. With an inflation taget, when negative demand shocks reduce inflation below target, the market expectation would be that future inflation would be above target.
ThomasH perhaps a lot of it has to do with an internal confusion, perhaps not entirely conscious between “targets” and “triggers”. And we see this actually explicit in the whole conept of NAIRU. Because note the inclusion of the word “Accelerating”.
Now if we step back we can see that the concept of an absolute NAIRU where 5.5% is bad because inflation triggering but 5.6% is good because not makes little sense, you would have to adjust all that for things like U6 instead of U3 and labor force participation and different surveys. At best it can only be shorthand representing some sort of range for that particular number. And yet over my entire lifetime the Fed has treated ANY positive news on employment or real wage as a Danger Sign. Could THIS be the momeny NAIRU goes into play? Is Weimar right around the corner?
And the same I fear for the 2% inflation “target”. It is being treated much as the now more than challenged RR 90% Debt to GDP. I mean even if you took the latter seriously clearly there was no rule that would have made 89% ‘okay’ and 91% ‘time to get the wheelbarrow out so we can exchange dollars for a loaf of bread’. Yet there was clearly some attraction to estabishing a hard and fast rule beyond which “Here Be Dragons” so don’t even go THERE.
So unless we manage to implement some sort of a “No-trigger warning” when it comes time to reporting inflation the idea that people should just treat upsides and downsides as logical variations around the mean just may not be operative. For psychological reasons if nothing else – why take the risk? (Particularly since the risk of exceeding the target falls mainly on bond and asset holders and the gains fall mainly to workers and debtors).
@ Bruce Webb,
Your explanation of targets vs triggers seems reasonable. The way I think an IT should work is the same as a price level trend target. What you are saying I think is that whatever is targeted won’t work if positive departures elicit more adjustment than negative one do. If inflation targeting is to be interpreted as a guardrail on the edge of the abyss, then clearly 2% is way too low.