Will Federal Reserve Chairman Ben Bernanke, at his speech today at the Fed’s symposium in Jackson Hole, Wyoming, announce the possibility of negative interest rates? It doesn’t seem likely, but he could and—if you are seriously worried about deflation—should.
Alan Blinder, in yesterday’s Wall Street Journal (“The Fed Is Running Low on Ammo”), suggested that it “may sound crazy, but central bank reserves can pay negative interest rates.” He’s certainly right. As discussed in more detail in my May 2009 article, “Why Not Negative Interest Rates?” negative interest rates not only are theoretically possible, but have actually occurred. (Of course, interest rates can be negative in real or inflation-adjusted terms, while still positive in nominal terms. What we mean here are negative nominal interest rates.)
So, although people often write about the “zero bound” for interest rates, in fact interest rates do not have a zero bound. For a situation which combines significant deflation with a high load of debt—a toxic combination—negative interest rates may be just what the doctor should order.
The obvious candidate for where to establish negative interest rates is indeed on excess reserves being held by banks at the Fed—at the moment about $1 trillion in idle funds. These represent the banking equivalent of stuffing currency in the mattress. If banks were faced with negative interest rates on these deposits, as Blinder suggests, it would increase the incentive to make loans or investments instead.
In June 2003, Fed Governor Bernanke asked, “whether it would make sense tactically to say publicly that we are willing to lower the federal funds rate to zero if necessary … there would no longer be a feeling in the market that we have reached the end of our rope.”
In August 2010, one could similarly ask “whether it would make sense tactically to say publicly that we are willing to go to negative rates if necessary … there would no longer be a feeling in the market that we have reached the end of our rope.”
Could the Fed chairman be willing to say that? We’ll see.
Image by Cliff1066.
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