The interest rate myth, again

Distinguished economist Greg Mankiw has just written on his blog that his formula for setting the federal funds rate “recommended a deeply negative federal funds rate during the recent severe recession.” He continues, “Of course, that is impossible.” No, it isn’t. Negative interest rates are perfectly possible, as most recently shown by the sale of short-term German government bills for negative yields. We don’t seem to be able to rid economics of the myth that interest rates cannot go below zero.

The Federal Reserve is not willing to try them, however, although it has tried many other things. I speculate that this is because the Fed prefers to pursue credit allocation to mortgages through expanding its own balance sheet, in order to try to prop up house prices.

2 thoughts on “The interest rate myth, again

  1. Great plan!. Cut the Fed Funds rate to -1% and the problem is solved. Brilliant.

    One problem you may have overlooked. The $4.5T money fund industry would all “break the buck” in a matter of hours.

    There are reasons for the zero bound. You’re messing with mother nature with this one.

    PS. US Bills have traded at negative yields on numerous occasions. When it happens, it’s destabilizing. The reason German short date paper went negative is that there is currently a panic in the EU funding markets.

    • Mr. Krasting, please re-read Mr. Pollock’s commentary. He makes no recommendation regarding fed interest rate policy. He merely states that it isn’t impossible to set negative fed funds rates. Whether the mutual fund industry would break the buck, mess with “mother nature”, or create destabilization is in the realm of cause and effect, and has nothing to do with his point.

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