Narayana Kocherlakota Advocates Negative Rates and Criticizes the Conduct of US Fiscal Policy

Link to Narayana Kocherlakota’s Wikipedia page

On March 25, 2015, Narayana Kocherlakota sat in my office at the University of Michigan; we talked especially about negative interest rate policy. (See my preface to “Yichuan Wang on Narayana Kocherlakota and coauthors’ “Market-Based Probabilities: A Tool for Policymakers.”) He has since emerged as a major presence on Twitter; you can get a sense of this from my storified Twitter discussion with him: “Narayana Kocherlakota and Miles Kimball Debate the Size of the US Output Gap in January, 2016.” But don’t miss the chance to go to Narayana’s Twitter homepage as well. 

Yesterday, February 9, 2016, Narayana posted: “Negative Rates: A Gigantic Fiscal Policy Failure,” arguing quite explicitly for negative interest rates. Narayana writes about moving to negative interest rates. In his words:

1. It would facilitate a more rapid return of inflation to target.
2. It would help reduce labor market slack more rapidly.
3. It would slow and hopefully reverse the ongoing and dangerous slide in inflation expectations.

So, going negative is daring but appropriate monetary policy.

Narayana then goes on to criticize low levels of government investment given very low interest rates. This is an issue I have written about more than once, in a way generally sympathetic to Narayana’s point:

• What to Do When the World Desperately Wants to Lend Us Money
• One of the Biggest Threats to America’s Future Has the Easiest Fix (coauthored with Noah Smith)
• Capital Budgeting: The Powerpoint File
• Discounting Government Projects

I don’t come down in exactly the same place as Narayana, though. As I noted to John Conlin, who pointed me to Narayana’s post, I tend to think that monetary policy should be used to stabilize the economy, not fiscal policy. Once monetary policy does its job, if the medium-run natural rate of interest is still low, then we should undertake more government investment. (See “The Medium-Run Natural Interest Rate and the Short-Run Natural Interest Rate.”) And we should undertake crucial government investments even if interest rates are high after the economy recovers. But it is just too hard to time government investment effectively in order to stabilize the economy.

Monetary policy has a lag of 6 to 12 months in its effects. Even so, it is much nimbler than government investment. Private investment and imports and exports can’t turn on a dime; hence the 6 to 12 month delay in the effect of monetary policy. But government investment typical takes even longer than that to turn around. 

Using monetary policy as it should be used, aggregate demand is no longer scarce. Monetary policy can provide all the firepower needed. But fiscal policy can still play a role. Fiscal policy is most helpful in economic stabilization under two circumstances:

1. When (as is not the case for government investment) it can move faster and act faster in its effects than monetary policy, or 

2. When monetary policy is somehow constrained. 

Other than automatic stabilizers, which are extremely helpful, but not enough by themselves, the one type of fiscal policy that acts fast is fiscal policy that affects household consumption which can realistically change within a matter of days. Some might think of tax rebates in this regard, but I have argued at some length that tax rebates are a strictly dominated policy in “Getting the Biggest Bang for the Buck in Fiscal Policy.” In brief, I argue that the ratio of stimulus to ultimate addition to the national debt is much more favorable for lines of credit from the government than tax rebates. For example, it is not unreasonable to think that, since much of it would be repaid, a $2000 line of credit from the government would ultimately cost the government about as much as a $200 tax rebate. But a $2000 line of credit is likely to provide a much stronger impetus to consumption than a $200 tax rebate. 

As for constraints on monetary policy, the zero lower bound is crumbling all around us. After that the most important constraint on monetary policy is the fact that so many European countries share their monetary policy in the euro zone. For these countries, fiscal policy–or if you want to call it that, credit policy of the sort I talk about in “Getting the Biggest Bang for the Buck in Fiscal Policy”–can be very helpful in adjusting the overall level of macroeconomic stimulus to different needs from one country to another in the euro zone. There may also be a place for government investment as a countercyclical tool in the euro zone. But given vigorous monetary policy, it might well be that government investment, even in the euro zone, might best be directed at medium to long-run considerations rather than short-run considerations. My posts bulleted above address some aspects of those medium- to long-run considerations. 

Note: Also, don’t miss my contribution to long-run fiscal policy as laid out in “How and Why to Expand the Nonprofit Sector as a Partial Alternative to Government: A Reader’s Guide.” 

The Swiss National Bank and Bank of Japan’s New Tool to Block Massive Paper Currency Storage

Haruhiko Kuroda, 31st Governor of the Bank of Japan

The Bank of Japan’s New Negative Interest Rate Policy 

The Bank of Japan surprised the world by going to negative interest rates on January 29, 2016. You can read more about that move in Reporting on Japan’s Move to Negative Interest Rates and in these 3 news articles (1, 2, 3). But there are important aspects of the Bank of Japan’s new policy that are only now being appreciated. 

I have written a great deal about negative interest rate policy. (I have organized relevant links here.) But, thanks to Noah Smith pointing me to Martin Sandbu’s February 4, 2016 article in the Economics “Free Lunch: There is no lower bound on interest rates,” I realize that the Swiss National Bank–with the Bank of Japan following in its footsteps–has hit upon an additional tool for blocking massive paper currency storage that I hadn’t thought of. Here is how Martin Sandbu describes it:

But the Bank of Japan’s set-up for negative rates, which apparently follows the Swiss National Bank’s, casts doubt on the premise that the nominal cost of holding cash is zero. As we have explained, if a private Japanese bank wishes to exchange its central bank reserves for cash, the BoJ will adjust the portion of its reserves to which negative rates apply by the same amount. That means any extra cash that a bank wishes to hold will cost it as much as if it kept it on deposit at the central bank.

And here is the description from the Bank of Japan’s official statement about its new negative interest rate policy:

2. Adjustment concerning a significant increase in financial institutions’ cash holdings 

In order to prevent a decrease in the effects of a negative interest rate due to financial institutions’ cash holdings, if their cash holdings increase significantly from those during the benchmark reserve maintenance periods, the increased amount will be deducted from the macro add-on balance in (2). In cases where the increased amount is larger than the macro add-on balance, the amount in excess of the macro add-on balance will be further deducted from the basic balance in (1).

A Negative Paper Currency Interest Rate on Cumulative Net Withdrawals from the Cash Window

What is fascinating is this: a central bank can effectively impose a negative interest rate on additions to cash holdings by saying that any bank with access to the cash window is on the hook for whatever paper currency interest rate the central bank decides to charge on cumulative net withdrawals of paper currency by that bank after a certain date regardless of who actually ends up with that paper currency. Then it is up to the bank to figure out how and whether to pass on to its customers the negative paper currency interest rate it faces on that extra paper currency. Martin Sandbu’s article has a nice discussion of how pass-through might work. 

One chink in the armor of this mechanism for imposing negative interest rates on cumulative net withdrawals of paper currency would be if a bank went bankrupt after withdrawing a huge amount of cash at the cash window and handing off that cash to favored individuals. But that doesn’t seem like a big issue. Surely the number of banks that have access to the cash window willing to intentionally go bankrupt to help favored individuals get paper currency not subject to the negative interest rate is limited, and there may be some way for the government to prosecute the individuals who organized this scheme of using bankruptcy to circumvent the negative interest rate on additional paper currency.     

No Limit to How Low the Marginal Paper Currency Interest Rate Through the Negative Rate on Cumulative Net Cash Withdrawals Mechanism Can Go

One thing that the Bank of Japan may not yet have realized is that banks can be charged for net cash withdrawals even beyond an amount equal to the bank’s initial reserves. As it is now, the policy is represented as a policy about how much of reserves is exempted from the negative interest rates, or even receives a +.1% interest rate, but that need not be the case. Banks can be charged interest on cumulative net cash withdrawals quite apart from how their reserve accounts are handled. For now, the Bank of Japan has made a good choice to charge the negative paper currency interest rate through the formula for interest on reserves, but it should not stop there if very large amounts of paper currency are withdrawn. 

The Central Bank Can Limit Cash Withdrawals by Limiting the Total Size of the Monetary Base

Speaking of the possibility of cash withdrawals exceed initial reserves, another additional tool that I will mention only briefly is that if negative interest rates are adequate to get velocity up on a given monetary base, limits on the monetary base may limit the total amount of paper currency that can be withdrawn. This is a point I take from Martin Sandbu, who wrote in “Free Lunch: There is no lower bound on interest rates”:

And how could private banks honour mass withdrawals of cash even if they wanted to? No law provides for the central bank to swap client deposits for cash; only central bank reserves. And despite the huge growth of reserves in recent years, these still amount to only a fraction (about one-fifth in the UK) of bank deposits.

What If the Paper Currency Interest Rate is Lowered in the Future?

It might seem unfair for a central bank to lower the interest rate on cumulative net cash withdrawals that are already out there. There is a flavor of retroactivity to it. But if a bank only gets a -.2% rate on net withdrawals after a certain date and -.1% before, then it might try to withdraw a lot of paper currency right before it predicted the paper currency interest rate on further net withdrawals after would be cut. If it knows the rate can be cut on what is already out there, there is no such incentive to pull out cash under the wire. 

An alternative to making rate cuts on net paper currency withdrawals retroactive to the inception of the negative interest rate policy would be to have a schedule saying that, for example, a bank gets -.1% on the first 5% of its previous year’s reserve balance in cash, -.2% on the next 5%, -.3% on the next 5% after that, etc.  

A Warning: Side Effects of a Negative Paper Currency Interest Rate on Cumulative Net Withdrawals from the Cash Window

Although the central bank can easily do so to the private bank, it is probably not as easy for that private bank to keep charging a retail customer a negative interest rate month after month on cumulative net cash withdrawals. In principle, a bank could keep charging such a “rental fee” on net cash out to a customer, but what is to stop a customer from withdrawing a lot of cash, and then cutting all ties to the bank? (This is analogous to the intentional bankruptcy discussed above, but much easier.) Even if a contract still obligated the former customer to keep paying the rental fee on the net cash out, it is a lot of trouble for the bank to track that customer down and collect the fee–especially for modest amounts. 

As a result, private banks are likely to charge a substantial one-time fee on withdrawal of cash to make it worth their while to give out cash, or impose severe restrictions on cash withdrawals. This will interfere with the normal use of paper currency. This may not happen immediately, but is likely to emerge over time (and of course depends on exactly what interest rate the Bank of Japan is imposing, and how long banks expect negative interest rates to last). 

What is worse, restrictions or fees on withdrawals by themselves will tend to push the value of paper yen in circulation–on which fees have already been paid–above the value of electronic yen. If banks charge a fee for giving out paper currency, so can retailers. In Japan, many, many retailers only accept paper currency even now. If paper currency is going at a premium, more and more retailers are likely to declare that they only accept paper currency. This further paperization of the Japanese economy will make negative electronic interest rates less effective. (The negative paper currency interest rates don’t do the trick because they are not passed through; therefore, the burden falls on the negative electronic interest rates and on transactions made in electronic form.)

In addition to these serious problems from a paper currency policy that pushes paper currency above par, the exact exchange rate between paper currency and electronic money could be quite volatile. That is, the effective exchange rate between paper currency and electronic money that follows a jagged path over time like a stock price plot as people get new information about the future. 

By contrast, in my main proposal of a time-varying paper currency deposit fee at the cash window, if a private bank passes the time-varying paper currency deposit fee to retail customers (including extra cash upon withdrawal), the effective exchange rate between paper currency and electronic money at the bank will follow a very smooth, sedate path. I recommend that smooth, sedate path–with a below-par rather than above-par value for paper currency.    

How the Bank of Japan’s Policy Uses Two Key Innovations I Have Made in Negative Interest Rate Paper Currency Policy

In addition to giving a well-attended presentation on “Breaking Through the Zero Lower Bound” at the Bank of Japan on June 18, 2013 (and on June 24, 2013 at Japan’s Ministry of Finance), I spent 2 weeks each in the summers of 2008 and 2009 as a visiting research fellow at the Bank of Japan, and have several former students on staff there. I also made a point of arranging a seminar at the Bank of Japan on June 8, 2010 (on an unrelated paper) in order to have a chance to remind the staff at the Bank of Japan about the potential of negative interest rate policy. So I am confident that some staffers within the Bank of Japan have read my work carefully (including my work with Ruchir Agarwal on the IMF Working Paper “Breaking Through the Zero Lower Bound,” which is prominently featured here). 

I have no idea whether those who actually designed the Bank of Japan’s new policy have read my work or not. Nevertheless the Bank of Japan’s new policy has the two key features that are my innovations over the negative interest rate paper currency policy tools laid out by Willem Buiter: 

1. Existing paper currency is used.
2. The policy is focused on the central bank’s interaction with private banks. The private banks are left to decide pass-through on their own.

The advantage of using existing paper currency is obvious. The advantage of letting private banks handle pass through is that the private banks, for their own benefit, will be inventive at trying to minimize the annoyance to customers from the negative interest rate policy as much as possible given what the central bank has done. In addition, having the central bank focus only on its interaction with private banks makes the central bank’s job more manageable. It doesn’t need to think through quite as many things, since the private banks have, in effect, been deputized to work out the details of what happens at the retail level. (One limitation to this principle is that there has to exist some way for the private banks to pass the policy through–or not–that goes some distance toward achieving the macroeconomic goals without serious side effects.)  

How the Bank of Japan’s Paper Currency Policy is Different from the One I Recommend

In my presentations to central banks around the world, I warn of the problems that arise from trying to restrict or penalize withdrawal of paper currency. We may soon learn more about these problems from experience. And of course the details of the policy matter. In the case of the Bank of Japan’s policy, the emergence of an above-par, jagged price of paper currency and further paperization of the economy by more and more retailers only accepting paper currency are the most worrisome problems.

Note that–as discussed above–these problems have to do with the particular difficulties private banks will have in passing through the negative paper currency interest rates in the form that the Bank of Japan is imposing them on the banks. If the banks could pass the negative paper currency interest rates on in a similar form, there would be no great problem.   

The best course would be to follow my recommendation of a gradually changing below-par value for paper currency at the cash window of the central bank. If restrictions, penalties or fees on withdrawals–or what will result in private banks imposing restrictions, penalties or fees on withdrawals–must be used, they should be used in combination with other policies, including policies that tend to push the price of paper currency down. The possibility of second- or third-best negative interest rate paper currency policies that try to keep the relative price of paper currency close to par is the subject of an upcoming post. 

Why the Bank of Japan’s Move is So Remarkable

I thought it would be at least another year–into 2017–before the Bank of Japan went to negative interest rates–partly because to do so would be a tacit admission that its previous QE-only policy was not working as hoped. It was a genuine act of courage for the Bank of Japan’s monetary policy committee to admit that it needed something more. I applaud them. 

But what is even more remarkable is that they were willing to begin to modify paper currency policy. And make no mistake, as a practical matter, it is paper currency policy traditions that create the zero lower bound. So the Bank of Japan has made a small step down the road toward abolishing the zero lower bound–a small step that could ultimately be part of a giant leap for humankind.

Update 1: A reader points out that the Bank of Japan’s statement of its policy above can easily be interpreted as applying only to a bank’s own holdings of paper currency, which would not include paper currency it passed on to customers. (Many people have, in fact, interpreted it that way.) In that case, this would be a charge for storage of paper currency rather than a charge for cumulative net withdrawals of paper currency by banks. If that is the right interpretation, I am glad I misunderstood the statement so I could see the interesting possibility of a charge on cumulative net withdrawals. But I am also glad to be corrected about what the actual current policy is.  

In the event, if a bank made large paper currency withdrawals to pass paper currency on to customers, I suspect the Bank of Japan would try to do something to discourage that flow. Since the Bank of Japan is making the policy itself (and there is a tradition in Japan of administrative discretion) a private bank should worry about what the Bank of Japan would do if the private bank became a conduit for a large amount of paper currency to customers. 

Update 2: The Swiss National Bank’s corresponding statement for its policy (on which the Bank of Japan’s policy is probably modeled) is clearer:

Minimum reserve requirement of the reporting period 20 October 2014 to 19 November 2014 times 20 (static component). –/+ Increase/decrease in cash holdings resulting from comparison of cash holdings in current reporting period and corresponding reporting period in given reference period (dynamic component) = Exemption threshold

Thanks to JP Koning for this point.

Update 3: Makoto Shimizu gives an answer to Update 1. This is so important, it has its own post. Don’t miss “Makoto Shimizu Reports on the Bank of Japan’s New Tool to Block Massive Paper Currency Storage.”

Reporting on Japan’s Move to Negative Interest Rates

Link to the article on wsj.com

Anjani Trivedi, Eleanor Warnock and Greg Ip’s Wall Street Journal article “Central Banks Go to New Lengths to Boost Economies: Bank of Japan’s move to negative rates is the latest attempt to spur growth,” is a good example of the still inadequate reporting about negative interest rates. The revision noted that it had input from Tommy Stubbington, whom I praised in “The Wall Street Journal Gets It Right On Negative Interest Rate Policy, Thanks to Tommy Stubbington,” and was noticeably better, though in a spotty way. Let me give my reactions to some important passages.

Basic Reporting

The reporting at the beginning of the article is well done. I particularly appreciated the discussion of international linkages:

Japan’s move washed through currency markets, driving the yen down by as much as 2.2% against the dollar, and showed how easing by one central bank puts pressure for similar moves by others.

By strengthening the dollar, the continued loosening of monetary policy in Japan and Europe could complicate the Fed’s aim of gradually notching up interest rates this year. Measured against a basket of 16 currencies, the dollar this week hit its highest level in more than 13 years.

and how massive paper currency storage has not yet appeared in Europe:

… the move in Europe into negative rates has so far created no evident disruptions for money-market funds or a flight to cash by depositors, giving a green light for banks to consider going further.

“Adverse effects on money market functioning have been limited,” Stanley Fischer, the Fed’s vice chairman, said in a speech this month. “Cash holdings have not risen significantly in these countries, in part because of nonnegligible costs of insuring, storing, and transporting physical cash.”

I was surprised by how low Sweden has gone:

No one knows how low negative rates can get before those costs become an inducement to hold cash, but probably beyond the minus .75% rate now charged in Denmark and the minus 1.1% in Sweden.

And the article pointed out an important fact, which I discussed on Wednesday in relation to two-tiered negative deposit rates in the euro zone:

Few banks have so far passed on those negative rates to small retail depositors.

Looking forward, this is an interesting prediction:

In a note to clients Friday, Citigroup economists predicted the ECB and the Swedish and Danish central banks would cut their policy rates even further into negative territory in coming months, and their counterparts in Canada, Australia, Norway and even China may do so “should macroeconomic conditions turn out even weaker than currently expected.”

Analysis

As the article moved from reporting to more analysis, the quality declined. For example, the authors needed a counterpoint to Raghuram Rajan’s declaration

… stimulus doesn’t cut it anymore and certainly monetary policy has largely run its course. 

Guess what–monetary policy hasn’t run its course at all. In my most recent visits to central banks, my advice has been to choose the policy rate as if there were no zero lower bound–because there isn’t a zero lower bound for any central bank that knows what it is doing. And increasingly, central banks do know how to defeat the zero lower bound. My bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” gets a steady stream of pageviews, many of which I am confident are from central bank staff around the world. And I have been to a fair number of central banks in person. For journalists to understand everything central bankers are thinking, they need to read some of what I have written. Otherwise, they will get things wrong.

Even more misleading is this quotation with no counterpoint:

Central bankers “are running out of things to do,” said Sean Yokota, head of Asia strategy at Nordic bank SEB.

This is first, false, since a lot remains to be done in the direction of negative interest rates. Secondly, it seems to suggest that negative interest rates are a last resort. No! Negative interest rates were always likely to be much more effective than quantitative easing. Quantitative easing was tried first primarily because the intellectual preparation for quantitative easing was further along than the intellectual preparation for negative interest rates when central banks felt the need for another tool.

The Power of Negative Rates

The reporting was fully appropriate in giving this quotation,

Despite the day’s surge, some investors remained skeptical about the lasting impact of the central banks’ efforts. “People are starting to feel more and more that central bank action is having less and less fire for effect,” said Ian Winer, head of equities at Wedbush Securities.

but I want to take issue with Ian Winer himself. I want to insist that the power of negative interest rates be judged per basis point. Given the mild negative interest rates so far, the effects have been substantial per basis point reduction. The size of the effects is especially impressive when one realizes that only the weak version of negative interest rates has been used so far. As I wrote in “The Swiss National Bank Means Business with Its Negative Rates,”

There is a world of difference between a central bank that cuts some of its interest rates, but keeps its paper currency interest rate at zero and a central bank that cuts all of its interest rates, including the paper currency interest rate. If a central bank cuts all of its interest rates, including that paper rate, negative interest rates are a much fiercer animal.

The ability to reduce the paper currency interest rate using the tools you can see discussed here makes it so that interest rates can be reduced by as many basis points as needed.

How Much More Slack Is There There in Japan’s Economy?

It is very difficult to know exactly how much slack is left in Japan’s economy. I lean toward the view that there is still substantial slack left. Try this thought experiment on for size. Suppose that, instead of trying with all its might to talk inflation up, the Bank of Japan were doing everything it could to keep inflation expectations down while using negative interest rates to stimulate the economy as much as it is being stimulated under current policy. Would inflation now be rising? If your answer is no, then you think the Japanese economy has slack. 

Even if, contrary to my own guess, the Japanese economy is already at its natural level of output or a little beyond, given the objective of raising inflation, it doesn’t make sense to think that monetary policy has been too stimulative until there is more inflation than desired, or a path that looks as if it will lead to more inflation than desired. One of the reforms mentioned in the article is really about trying to raise inflation:

Labor reforms that give benefits to contract workers so wages can rise more broadly

This seems like a reform aimed at getting more inflation. But given that as much monetary stimulus as desired can be provided by negative interest rates, there is really no reason to desire more inflation. Japan can stimulate its economy as much as desired without any extra inflation. It certainly should be willing to risk more inflation than the current level of inflation in order to learn more about what its natural level of output is, but if negative interest rate policy is fully embraced in the way I have recommended, there is no longer a strong reason to desire more inflation. Other than the neutering of monetary policy by the zero lower bound, low inflation has not caused Japan serious problems (perhaps in part because its annual bonus system reduces downward nominal rigidity of wages in Japan). And the zero lower bound is a dragon that can easily be slain now that the soft underbelly of the zero lower bound has become fully apparent.

Thinking About New Financial Technologie—Izabella Kaminska and Gillian Tett on Excitement about Fintech Eclipses Basel III at Davos →

Financial technology could take over an important part of the market fast. It is important that regulations not be used to stop progress. To make sure of that, there should be a regulatory safe harbor saying any financial technology that meets three conditions beyond the usual one of in fact doing what it seems to be telling users that it is doing should definitely be allowed: 

1. The technology is based on accounts that are 100% backed by central bank reserves. Obviously, this means that central banks have to make reserve accounts readily available to new fintech companies. 
2. All records of all transactions using the technology, and all complaints received by the company are immediately available in easy-to-read electronic form and can be freely inspected by the government without a warrant. That is, everyone using the technology signs a contract that makes everything they do with the technology totally transparent to the government.
3. Funds held on behalf of customers have a nonzero interest rate tied to a market-based measure of prevailing short-term interest rates. (This is to make sure the technologies are robust to possible negative interest rate situations.) 

This is not at all to say that all new financial technologies must meet these three criteria. But there should be absolutely no prior restraint of anything that does meet these three conditions and the usual “doing what you seem to be saying you will do” condition. The “total transparency to the government” rule should make it easy to detect problems as they arise.

How to Handle Worries about the Effect of Negative Interest Rates on Bank Profits with Two-Tiered Interest-on-Reserves Policies

In a January 25, 2016 Goldman Sachs bulletin, analyst Dirk Schumacher writes:

We expect the ECB to ease monetary policy further at the March meeting via an extension of the APP programme until September 2017 and a cut in the deposit rate by 10bp to -0.4%.

I think it would be better policy for the ECB to go straight to the -.75% that has been pioneered by the Swiss National Bank, but every bit of interest rate cuts helps at least some in the current situation where the eurozone needs so much additional stimulus. 

The Goldman Sachs report also has a long discussion of the worries members of the European Central Bank’s monetary policy committee have about the effect of lower interest rates on bank profits. In the extreme, if bank profits go down too much, banks may exert their oligopoly power to raise lending rates to raise earnings in the short-run to compensate. The issue is that banks will want to shield some of their depositors from the negative rates, so they don’t want to fully pass through negative rates to their customers.

A “two-tiered system” in which a certain amount of deposits at the central bank get a zero interest rates and amounts above that get a lower interest rate seems hard to some of the ECB’s central bankers because that might hit banks harder in some countries than others. To me, the basic solution if a two-tiered system is desired is fairly straightforward: the two-tiered system should be designed to be equivalent to a subsidy to the deposit rates for household accounts below a certain size–say enough to provide a zero interest rate on an average balance over a month of 1000 euros worth of bank deposits per adult, for that adult’s main bank. (Those with more than one bank would have to designate one bank for this effective subsidy.) 

The value of tying the amount of deposits with the European Central Bank that a private bank can get zero interest rates on to the amount of household balances from accounts with 1000 euros or less is that this makes it natural for the private banks to pass on the negative interest rates to commercial and to the excess over 1000 euros in large accounts (which is helpful for transmission of the effects of the negative interest rates) while small household account are shielded from the negative interest rates (which is helpful politically). And it is easy enough to understand the rule and its intent that banks will be able to explain why they need to transmit negative interest rates to those with large accounts. (Of course, the cutoff could be set at some other level than 1000 euros, if desired.) And this policy is fully consistent with keeping bank profits unharmed by negative interest rates as long as they do pass on negative interest rates to large accounts and commercial accounts as they are supposed to.  

Experience in Switzerland, Denmark and Sweden suggests that the more sophisticated bank customers who have large accounts or have commercial accounts adjust quickly to negative interest rates after a few weeks of bitter complaining. The objective of a two-tiered system is to have negative interest rates prevail generally in the markets, but shield from negative interest rates those who are the least able to understand negative interest rates and perhaps to accomplish a bit of redistribution as well–though clearly not redistribution toward the poorest of the poor, who may not have bank accounts at all. 

Note that by buying enough bonds and crediting the sellers with reserves–or by lending reserves–the European Central Bank can guarantee that there are much more reserves in the system than would be subject to the zero interest rate. Thus, the other interest rate will be the marginal one. And it should go without saying that the rate on short-term bonds should be pushed close to the most negative deposit rate. Keeping the bond rate at zero would not be cutting rates enough.

Why a Weaker Effect of Exchange Rates on Net Exports Doesn’t Weaken the Power of Monetary Policy

Link to this post on Medium

On New Year’s Day, 2016, I tweeted what you see above.

Let me explain at greater length. Paul Hannon is right in his Wall Street Journal article “Why Weak Currencies Have a Smaller Effect on Exports” in writing:

When a country loosens its monetary policy, interest rates fall and investors tend to pull their money out in search of higher yields elsewhere, pushing down the currency’s value.

And the article goes on to make a very interesting point about how global supply chains might be blunting the effect of a given change in the exchange rate on net exports:

Measuring the impact of global supply chains on trade flows is the task of a project undertaken by the Organization for Economic Cooperation and Development and the World Trade Organization. …

Economists at the International Monetary Fund and the World Bank have used those measures to assess whether currency movements have the same impact they once did on exports and imports. They found that the effect has in fact reduced over time, by as much as 30% in some countries.

But Paul Hannon’s overall subtext that this weakens the power of monetary policy is wrong. Start with the basic accounting identity of international finance that Paul alludes to and that I discuss in detail in my post “International Finance: A Primer”: the provision of domestic currency to those outside one’s currency zone through net capital outflows NCO (and through other channels as remittances of foreigners sending money to their families back home) must lead to an increase in net exports NX of equal magnitude. (Also see my column “How Increasing Retirement Saving Could Give America More Balanced Trade.”) The only wiggle room in this statement is that for whatever period of time someone abroad are willing to temporarily hold a growing pile of our domestic currency provided byintentional purchases of foreign assets that counts as an unintentional capital flow in the reverse direction. As soon as they want to unload our currency, our currency will make its way back home one way or another. (If people abroad decided to hold a pile of our currency more permanently, that rightly counts as an intentional capital flow in the reverse direction, canceling out all or part of the initial capital flow.)

Of course, the way the price system guarantees the return home of domestic currency that is unwanted abroad is through exchange rate movements. But the logic here means that exchange rates move as much as it takes to bring about the return of domestic currency that is unwanted abroad. So an increase in intentional capital outflow of $1 creates a $1 increase in net exports over whatever horizon it takes for domestic currency that is unwanted abroad to make its way back home. The relevant horizon is not instantaneous, but foreigners are unlikely to be willing to hold piles of unwanted domestic currency for very long. (Of course, governments sometimes choose to override this part of the prices system by imposing fixed exchange rates. Fixed exchange rates work by having the government equal and opposite capital flows to neutralize the effect of changes in intentional private capital flows on exchange rates.)

When the central bank cuts interest rates, the initial step in affecting international finance is in generating net capital flows of a certain size as domestic investors search for higher returns abroad, and potential foreign investors think better of sending their funds to a low-interest-rate country. These capital flows then have a 1-for-1 effect on net exports after the recycling of currency described above, regardless of the elasticity of net exports with respect to the exchange rate.

If net exports are relatively insensitive to the exchange rate, the exchange rate will simply move more. Indeed, many casual observers are struck by the large fluctuations often seen in the exchange rate. Large fluctuations in the exchange rate are exactly what one should expect if net exports are relatively insensitive to movements in the exchange rate, as I wrote about in“The J Curve.”

What would affect the potency of monetary policy is if the effect of a given movement in interest rates on international capital flows went down. But I don’t know of anyone claiming that is the case. (What I do hear a lot of is the speculation that cutting interest rates into the negative region would be especially salient to investors and so might have a particularly large effect on international capital flows — which would then increase the potency of monetary policy.)

One particular area where the discussion above matters is in assessing Japanese monetary policy. How much stimulus the Bank of Japan has achieved through the international finance channel is much better measured by the size of the international capital flows generated than by the size of the exchange rate movements that result. Because overall Japanese investors have a particularly strong home-bias, the effect of monetary policy on international capital flows may be weaker than in most other countries. But it is factors such as home-bias that matter for the contribution of international finance to the potency of monetary policy, not the elasticity of net exports with respect to the exchange rate. (On Japanese monetary policy, also see “Is the Bank of Japan Succeeding in Its Goal of Raising Inflation?”, “Japan Should Be Trying Out a Next Generation Monetary Policy” and “QE May or May Not Work for Japan; Deep Negative Interest Rates Are the Surefire Way for Japan to Escape Secular Stagnation.”)

To repeat: Weak effects of a given size of exchange rate movement on net exports does not blunt the effects of monetary policy because exchange rates do whatever it takes to make net exports equal to net international capital flows.

Breaking Through the Zero Lower Bound and Electronic Money: The AEA Meeting Presentation

I wanted to invite all of you who are in San Francisco for the American Economics Association meetings to my presentation tomorrow (Monday) on how to eliminate the zero lower bound. You can see the details above.

I would love to meet and get a chance to talk in person to anyone who is a regular reader of this blog right after this session.

I trimmed down my Powerpoint file to this given the time constraints, and tried to get to the key idea quicker, even before getting to the “18 misconceptions.” Then it will be OK if I don’t manage to address all 18 misconceptions, especially since people are likely to ask questions that highlight some of the others.

If you want more background before coming, take a look at

How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.

Update: It was a great session. Ken Rogoff could not make it due to his wife’s illness; I highly recommend the other paper presented by the Bank of England’s John Barrdear and Michael Kumhof: “The Macroeconomics of Central Bank-Issued Digitial Currency.”Andrew Rose was my discussant. He was very positive but less optimistic than I am about how soon the zero lower bound will be effectively eliminated. I was tickled that–like Ken Rogoff at the Chief Economist’s Conference at the Bank of England last May–Andrew described me as “evangelical” about negative interest rate policy.

QE May or May Not Work for Japan; Deep Negative Interest Rates Are the Surefire Way for Japan to Escape Secular Stagnation

Link to “Bank of Japan’s QE efforts seen stimulating inflation” on MarketWatch

In my view “secular stagnation” is simply a name for being stuck at the zero lower bound. Yimian Wu interviewed me in an article for MarketWatch about whether Japan was on the road to getting the higher inflation it wants in order to make the zero lower bound less binding. In the article she writes:

University of Michigan economics professor Miles Kimball, said Japan should keep stimulating its economy until it is overheated to a point that the inflation rate is higher than desired.

This deserves clarification. What I said is this: I think there is still a lot of slack in the Japanese economy, and I will only believe that the slack in the Japanese economy is exhausted when Japan gets more inflation than it wants. To find out exactly how much slack it has, it is worth it for Japan to risk higher-than-desired inflation.

When I walk around Tokyo, I see many workers doing low-productivity activities that no one would ever be paid to do in the US. So I think there is a lot of potential to increase output per work hour by having workers work more intensely or do higher productivity activities as demand picks up. 

Hanging on to workers even if there isn’t much of any great importance to do is sometimes called “labor-hoarding.” The amount of labor-hoarding in Japan is reflected by its historically high percentage of extra output from each percentage point reduction in unemployment in Japan’s version of Okun’s law. And historically, Japan has been able to have quite low unemployment rates without accelerating inflation.  

Yimian goes on to write about her phone interview with me:

However, he said Japan’s large-scale QE might have some side effects that can’t be predicted. “We knows a fair bit about what it (quantitative easing) does with a certain dosage, and then you triple that dosage and nobody knows.”

Instead of quantitative easing, Kimball advocated negative interest rates. In a phone interview, he explained that cutting interest rates, even below zero, would have a more direct effect in stimulating the economy than increasing long-term bond purchases.

In addition to the phone interview, Yimian emailed a set of questions, which I answered as follows:

Yimian: How would you comment on Japan’s Quantitative Easing from 2001-2006? It clearly did not help improve inflation but without the QE, would Japan’s economy then be worse? Did it increase economic activities?

Miles: The size of QE during that period was quite small. I wouldn’t have expected it to do much, and it didn’t do much. 

Yimian: How would you comment the QE starting in 2013? When do you expect Japan would exit QE this time? When do you project Japan can hit the 2 percent inflation target?

Miles: Here is what I have written on recent QE in Japan:

• Is the Bank of Japan Succeeding in Its Goal of Raising Inflation?
• Japan Should Be Trying Out a Next Generation Monetary Policy

With a negative interest rate policy, as I would recommend, it is not necessary to hit a 2% inflation target. What matters is getting to full employment, which is quite achievable. Once Japan is at full employment so people can easily find jobs, the Japanese government should take measures to make layoffs easier so that people can be steered away from less productive toward more productive work.  

Yimian: Do you think a large scale of QE is sustainable for Japan, considering its speed and scale of asset purchase? How would you compare the two QE programs, in terms of goal, scale and impact? Did the two QE spur company borrowing and consumer spending? Real wages and household savings seem to continue declining, how will QE work if consumers have less to spend and consumption tax is increased?  

Miles: QE is a very risky way to go because it might not work. Also, no one knows the side effects of very large doses of QE. There is no real experience from other countries in the use of QE starting from such a low level of inflation. The surefire way to get the economy to full employment is to use negative interest rates.

… I have links to other things I have written and a video of an interview you should look at here:

• How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide

Also, you should be aware that many of the shorter pieces I have written on negative interest rate policy have been translated into Japanese:

• http://supplysideliberaljp.tumblr.com/

The Wall Street Journal Gets It Right On Negative Interest Rate Policy, Thanks to Tommy Stubbington

Link to the article on wsj.com. Link to Google search for the article.

The Wall Street Journal has been slow to understand the potential of negative interest rate policy that I have laid out in various ways. But now, thanks to Tommy Stubbington–who interviewed me at length last Thursday–the Wall Street Journal has done an excellent front page treatment of negative interest rate policy. The whole article is great for giving the current context of negative interest rates in Europe, but below are the passages that most closely reflect Tommy’s interview of me. The first bit below has the same message as the title of my recently published paper “Negative Interest Rate Policy as Conventional Monetary Policy.” The rest should also be familiar to those who follow supplysideliberal.com:

Europe’s economic stagnation has proved so long and intractable that the region’s central banks are cutting interest rates to spur their economies. If it helps to move rates from 1% to 0.5% and 0.5% to 0%, why not try minus 0.5%? …

There is no hard limit on how low they can go. If commercial banks start widely imposing negative rates on retail customers, physical cash might look attractive. After all, it has a rate of 0%, although it isn’t without cost. One needs vaults and guards to store it, and it is no good for buying merchandise online.

Still, some economists said negative rates can be a powerful stimulative tool, if central banks can fully harness them.

Miles Kimball, an economist at the University of Michigan, has been preaching the gospel of deeply negative rates to central banks. When demand for money is low, as it is during a deep recession, Mr. Kimball argues, central banks should make borrowing as easy as necessary, even if that means paying banks to do it.

Mr. Kimball has a novel way around the physical-cash problem: make bank notes less valuable. He proposes that the Federal Reserve set an exchange rate between bills and electronic money. If it wanted, say, a minus 1% rate, it could decree that a $100 bill deposited in a year’s time would yield a $99 credit to a bank account. …

The interest in such schemes isn’t purely academic. With rates still at zero in much of the developed world years into the postcrisis recovery, central bankers may find themselves facing the next recession without much room to cut.

“It’s wrong to say central banks have run out of ammunition,” said Mr. Kimball. “Negative rates can be on tap before the next recession. There’s no limit to how deep we can go.”

US Law for the Tussle Between Different Modes of Payment

Customer choices between different modes of payment (paper currency, check, credit card, debit card, etc).–and what retailers do in relation to those choices– are important for understanding the effects of paper currency policies intended to enable deep negative interest rates when deep negative interest rates are called for. So it is worth knowing the law that applies to merchants trying to influence the mode of payment a customer uses among the modes of payment the merchant accepts. 

In part because my wife only recently retired as a massage therapist, our household received many copies of a notice from American Express, dated October 7, 2015 saying something quite interesting. I quote:

A federal court has ruled that American Express violated the law by prohibiting merchants from influencing the payment form that their customers use. As a result of that ruling, you may now favor any credit card brand that you wish, by, for example, communicating to customers which credit card brand you would prefer that they use, telling customers which credit card grands are the most or least expensive for you, or offering discounts or incentives to customers to use the credit card grand you prefer. Consistent with the federal court’s ruling, you may not, however, disparage or mischaracterize the American Express brand or impose a surcharge (as opposed to a discount) on customers who use an American Express credit card. 

To influence the credit card that a customer uses, you may employ any of the practices listed in Secton III.A of the court’s order, including:

• Offering a discount or rebate, including an immediate discount or rebate at the point of sale;
• Offering a free or discounted product;
• Offering a free or discounted service;
• Offering an incentive, encouragement, or benefit;
• Expressing a preference for a particular brand or type of card;
• Promoting a particular brand or type of card through posted information, through the size, prominence, or sequencing of payment choices, or through other communications to the customer; 
• Engaging in any other practices substantially equivalent to these.

To review all of the applicable terms and conditions, please refer to the court’s order, a copy of which may be found at [this link]. …

If you choose to attempt to influence a customer’s choice of credit or charge card, you must reasonably indicate that you accept American Express Cards by posting signage, either at the point of sale (including online or on mobile services) or at the store entry, or by communicating orally that you accept the American Express Card prior to the request for authorization of the transaction. For example, you may satisfy this requirement by displaying a sticker at the point of sale or at the store entrance indicating all brands you accept that includes the American Express log. …

To the extent that your Card acceptance contract, or other agreement that governs your acceptance of American Express Cards, contains provisions that are inconsistent with the federal court’s ruling, American Express will not enforce those provisions. 

American Express is presently appealing the federal court’s ruling. If the federal court’s ruling is reversed or modified as a result of the appeal, American Express reserves all rights to cancel or revise these modifications.

Mike Bird on Negative Interest Rate Policy | Business Insider

Link to the article on Business Insider

Despite an inflammatory picture and title, Mike Bird’s November 4, 2015 Business Insider article “This is how a central bank could kill off cash and bring in negative interest rates on your savings” is an excellent treatment of negative interest rate policy. Mike discusses at length my new paper “Negative Interest Rate Policy as Conventional Monetary Policy,” and provides helpful context.

Here are the two passages giving Mike’s assessment of the future for negative interest rate policy:

Since the financial crisis, the world’s understanding of economics has been undergoing a lot of rapid change.

Ideas that would have been considered crazy just a decade ago are now seen as much more likely.

One of those ideas is that central banks could bring in negative interest rates. 

However uncomfortable you are with the idea, you’d better get used to it. What HSBC chief economist Stephen King called the world economy’s “Titanic” problem is going to put governments around the world in a massive bind whenever the next recession hits.

Every lever of economic policy is pretty much tapped out, either for economic or political reasons: Finance departments and heads of government seem strongly against fiscal stimulus. Quantitative easing has been fairly unpopular, and its reputation among academics and economists is mixed at best.

In short, the world’s economy is an ocean liner, and there aren’t enough lifeboats. Despite objections, it may well be that negative interest rates are the path of least resistance.

Paul Taylor and Balazs Koranyi: ECB Rate Setters Converge on December Deposit Rate Cut →

Here is the most interesting quotation from this Reuters article:

Another Governing Council member also argued for a bigger deposit rate cut, saying it could go from -0.20 percent to -0.50 percent or even -0.70 percent after the Danish and Swiss examples.

The rate setter said that “zero lower bound”, a term meaning the bottom for interest rates, either “no longer exists, or if it does it is well below zero”.

Negative Interest Rate Policy as Conventional Monetary Policy

Here is a link to my first published journal article on negative interest rates: “Negative Interest Rate Policy as Conventional Monetary Policy,” in National Institute Economic Review (pdf). And here is the abstract page on the journal’s website.

Mario Draghi on Negative Interest Rates and Other Policy Tools—October 31, 2015 Interview by Alessandro Merli and Roberto Napoletano

Link to Wikipedia article on Mario Draghi

Mario Draghi gave a remarkable interview on October 31, 2015, labeled on an official webpage of the European Central Bank as “Interview with Il Sole 24 OreInterview with Mario Draghi, President of the ECB, conducted by Alessandro Merli and Roberto Napoletano.” I am grateful to Mike Bird and JP Koning for alerting me on Twitter to the importance of this interview.

To emphasize the points Mario Draghi is making about the role of various policy tools going forward, I have organized under my own headings what I consider the passages from the interview that I consider most important in their application to the future and to other central banks as well as the ECB. Mario Draghi has been head of the European Central Bank during a crucial period of time; I omit the parts of the interview focused primarily on reviewing that history, and focusing on the eurozone-specific issues.

To preview what is below, I include the Q&A about quantitative easing primarily as context. In the discussion of negative interest rates, Mario Draghi’s statement that 

• The lower bound of the interest rate on deposits is a technical constraint and, as such, may be changed in line with circumstances. 

is especially important. Compare this to the exact words of the statement I have urged central bank officials to make: 

From a technical point of view, we know how to eliminate the zero lower bound. 

On the truth of that statement, see my IMF Working Paper with Ruchir Agarwal, “Breaking Through the Zero Lower Bound,” which came out on October 23, 2015. (Also see my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.”)

Mario Draghi makes many other important points in the interview with which I am in strong agreement:

• international monetary policy coordination is not essential; it is OK if each central bank takes care of its own jurisdiction
• government investments are the safest type of fiscal policy, but good government investments can be hard to find
• supply-side reform is important; appropriate stimulative monetary policy is helpful to supply-side reform or in some cases neutral for supply-side reform

Here are the parts of the interview focusing on these issues:

Quantitative Easing

Q: You have always said that this outcome depends on the full implementation of your monetary policy and you have added on a number of occasions that there is flexibility in your asset purchase programme in terms of its size, composition and duration. You have also said that the next meeting on 3 December 2015 is when you will “re-examine” these aspects. The financial markets read this date as being decision time for the ECB. Is this interpretation correct? Have you started to consider the relative merits of these three types of action, which could have different effects? Do you envisage using them simultaneously?

Mario Draghi: If we are convinced that our medium-term inflation target is at risk, we will take the necessary actions. In the meantime we are assessing whether the change in the underlying scenario is temporary or less so. Moreover, after the meeting in Malta, we asked all the relevant committees and ECB staff to prepare analyses of the relative effectiveness of the different options for the December meeting. We will decide on this basis. We will see whether a further stimulus is necessary. This is an open question. The programmes that we have put together are all characterised by their capacity to be used with the necessary flexibility.

Negative Interest Rates

Q: However, for the first time you mentioned a cut in the ECB’s bank deposit rate and you said that “things have changed” since you had stated that -0.20% was the minimum lower bound. Can you explain what has changed?

Mario Draghi: The circumstances informing the decision to reduce the bank deposit rate to its current level actually consisted of a macroeconomic framework that has since changed. The price of oil and the exchange rate have changed. I would say that the global economic situation has changed. The interest rate on deposits could be one of the instruments that we use again. Now we have one more year of experience in this area: we have seen that the money markets adapted in a completely calm and smooth way to the new interest rate that we set a year ago; other countries have lowered their rate to much more negative levels than ours. The lower bound of the interest rate on deposits is a technical constraint and, as such, may be changed in line with circumstances. The main test of a central bank’s credibility is – as I have said before – the ability to achieve its objectives; it has nothing to do with the instruments.

Q: So, you see cutting the bank deposit rate as an instrument that can be used at the same time as the amendments to QE?

Mario Draghi: I would say that it is too early to make that judgement.

Q: In Malta, you also said you had discussed “some other monetary policy instruments”. What did you have in mind?

Mario Draghi: It would be too early at this stage to restrict the menu of instruments that will be assessed by the relevant committees and ECB staff. The existing menu is nevertheless extensive – you only have to look at what has been done in the past three years. However, it is too early to say in any case that “this is the menu” and that “there is nothing to add”.

International Monetary Policy Coordination

Q: You spoke earlier about the global macroeconomic environment which is changing. The Vice Chairman of the Federal Reserve System, Stanley Fisher, said that the Fed today takes much greater account of international factors than it did up until a few years ago. Is this true of the ECB as well? And does the Fed’s delay in starting to raise rates influence in some way your decisions, considering that the exchange rate is not a policy target?

Mario Draghi: As I said, external circumstances, the assumptions underlying our forecasts, are important because they influence inflation expectations, and therefore the profile of the return towards price stability and of the growth rate. They form part of the set of information that we, like the other policy-makers, use to take our decisions. As far as the Fed is concerned, there’s no direct link between what we are doing and what they are doing. Both central banks have their mandate defined by the jurisdiction in which they operate, for them it’s the United States, for us it’s the euro area.

Fiscal Policy

Q: In Lima you said that high-debt countries had to prepare for the day when they suffer from the impact of higher yields. At the same time, these countries suffer but also from the fact that inflation is very low, making debt reduction complicated. Isn’t this an even more serious risk? In Europe an increase in yields is not imminent, while too low inflation is making itself felt.

Mario Draghi: Low inflation has two effects. The first one is negative because it makes debt reduction more difficult. The second one is positive because it lowers interest rates on the debt itself. The path on which fiscal policy has to move is narrow, but it’s the only one available: on the one hand ensuring debt sustainability and on the other maintaining growth. If interest rate savings are used for current spending the risk increases that the debt becomes unsustainable when interest rates go up. Ideally, the savings are instead spent on public investments whose rates of return permit repayment of the interest when it rises. Growth is maintained today and future public finances are not destabilised when rates go up.

Obviously it’s not simple because, as we know, there aren’t many public investments with a high rate of return.

Supply-Side Reform

Q: Precisely on the subject of fiscal policy, there’s a lot of discussion in Europe at the political level. You are one of the first to use the expression “fiscal compact” in the European debate. Do you think now, looking back, that the degree of budget restrictions in the euro area was too strong after the crisis, in other words that there has been excessive austerity which has held back the recovery in the euro area?

Mario Draghi: First of all, there are countries which don’t have the scope for fiscal expansion according to the rules which we have given ourselves. Secondly, where this is possible, fiscal expansion must be able to take place without harming the sustainability of the debt. The high-debt countries have less scope to do this. But the fiscal space is not a fact of nature, it can be expanded, even a high-debt country can do it. How? By making the structural reforms which push up potential output, the participation rate, productivity, all factors which substantially boost the potential for future tax revenues. Increasing revenues on a permanent basis expands the possibilities for repaying debt tomorrow and at the same time creates the conditions for fiscal expansion today. The structural reforms are not popular because they involve paying a price today for benefits tomorrow, but if the government’s commitment is real and the reforms are credible, the benefits are gained more quickly and they include fiscal space.

Stimulative Monetary Policy and Supply-Side Reform are Complements or Separable, Not Substitutes

Q: The ECB’s Governing Council stands ready to increase monetary stimulus, should this be necessary. Your critics claim that this reduces the incentive to implement reforms.

Mario Draghi: I think that this is wrong for a number of reasons. First, if we look at the time frame of the main structural reforms implemented in the euro area over the past five years, it shows that this has no correlation with the level of interest rates on government debt in the countries concerned. Labour market reforms, for example, were implemented in both Spain and Italy when interest rates were already very low, and the same is also true in other cases. Second, the structural reforms cover a very wide range of areas. I do not believe, for example, that reform of the legal system has anything to do with interest rate developments. Third, recent experience shows that also when interest rates are high because a country’s fiscal credibility is threatened, this does not increase governments’ propensity to carry out reforms.

Q: How do structural reforms correspond to low interest rates?

Mario Draghi: Structural reforms and low interest rates complement each other: carrying out structural reforms means paying a price now in order to obtain a benefit tomorrow; low interest rates substantially reduce the price that has to be paid today. There is, if anything, a relationship of complementarity. There are also other more specific reasons: low interest rates ensure that investment, the benefits from investment and from employment, materialise more quickly. Structural reforms reduce uncertainty regarding macroeconomic and microeconomic prospects. Therefore, it is the opposite, rather than seeing an increase in moral hazard, I see a relationship of complementarity, of incentive. But it should never get to the point of having to consolidate the government budget when market conditions have become hopeless. Experience over recent years has shown that, in these circumstances, governments often make mistakes in designing economic policies, dramatically hike taxes and reduce public investment, without significantly reducing current spending, and postpone the structural reforms that require social consensus. In this way, they exacerbate the recessionary effects of the high interest rates and slow the fall of the debt-to-GDP ratio.

To conclude, in the euro area the markets do not typically influence the propensity of governments to carry out structural reforms; when this happens, because the governments have delayed the reforms for too long, and owing to the deterioration in the general conditions, the resulting economic policy action does not foster growth.