Brad DeLong Confirms that Not Having Negative Interest Rate Policy in the Monetary Policy Toolkit Makes People Afraid of Vigorous Rate Hikes to Control Inflation

In my September 5, 2022 post, “How a Toolkit Lacking a Full Strength Negative Interest Rate Option Led to the Current Inflationary Surge,” I write:

  • Thinking falsely that it couldn't fall back on negative rates, the Fed was too slow and timid in raising rates for fear that it didn't have the firepower to quickly reverse a recession if it went too far in raising rates.

In his Project Syndicate op-ed “When the Fed Stops Trying,” Brad DeLong confirms that this concern is on his mind, and indicates he thinks it has been on the mind of policy-makers in the Fed. Here are some key quotations from that piece, separated by added bullets:

  • Biden’s team knew that if the reopening inflation shock was too large, it could easily trigger an overreaction from the US Federal Reserve. That, eventually, would put America back in a semi-depressed or depressed state of secular stagnation, with little policy traction to respond to the next crisis or to promote a recovery.

  • The situation was thus analogous to Odysseus sailing between Scylla (a multi-headed monster) and Charybdis (a massive whirlpool). The Biden administration could either not try to navigate the strait at all (the first mistake), or it could try its luck with Scylla (secular stagnation) and Charybdis (stagflation).

  • Not without reason, financial markets seem to be betting that the Fed is about to make mistake number two: pursuing policies that will likely drag the US back toward secular stagnation. If past is prologue, we eventually will return to a scenario in which monetary policy is stuck at the zero lower bound. The economy may suffer another lost half-decade of growth, and socially and politically destabilizing inequalities will become even more pronounced.

In the last passage, Brad makes it clear the “secular stagnation” means being stuck at the zero lower bound. But of course, there is no zero lower bound. The idea that interest rates cannot be cut below zero, or cannot be cut very far below zero, is inside-the-box thinking—and the box is made of only flimsy material. The more I have worked on the details of how to best implement deep negative rates, the clearer it becomes that it is an available policy option. You can see the details in the resources laid out in my bibliographic post, “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” (You can always get there by clicking on the “NEG.RATES” button at the top of this blog.)

Also, despite West Virginia v. EPA, the authority of the Fed (a) to buy and sell Treasuries and (b) over its own reserve accounts needed to implement negative interest rate policy are so clearly authorized by statute, I believe the Fed, under current law, has the authority to implement deep negative rates along the lines of “How the Fed Could Use Capped Reserves and a Negative Reverse Repo Rate Instead of Negative Interest on Reserves.” (I am currently writing an article with a law professor, intended for a law review, making this case.)

Note that, as things stand, the likely timeline for needing negative rates allows plenty of time to lay out a monetary policy strategy including negative interest rates as part of the toolkit before we will need to actually implement negative rates.

Right now, one of the main objections people might make to negative interest rate policy is “You have to be kidding! How could you be talking about negative interest rates when inflation is so high. We need big interest rate hikes, not negative rates.” That is true as far as it goes, but I am arguing that the Fed’s slowness to raise rates is partly due to its fear that it doesn’t have the tools to deal with a serious recession. That raises the cost of raising rates too much—by a lot. The Fed will be scared to with inflation vigorously and promptly unless it also has the tools to deal with deflation. Imagine driving on a mountain road with a sheer drop to your right. Wouldn’t that increase the danger that you would hew to close to the middle of the road and collide with oncoming traffic? Or to take Brad’s analogy, if we know we can disarm and defang Scylla with negative interest rate policy, then we can steer far away from Charybdis.

A Portrait of Larry Summers

This article gives a good sense of the Larry Summers that I know—particularly how much he loves a good intellectual discussion from almost any starting point. Having Larry as one of my professors in graduate school and watching him during breaks at conferences gave me the view (which I still hold), that the most important economics is what happens in the hallways on those breaks (and often beyond, as those in a good discussion play hooky from the next formal talk). I draw from that premise the conclusion that the purpose of economic models is to train our intuition so that we are well prepared for such free-wheeling discussions.

Chimamanda Ngozi Adichie's Advice on the Benefits of Failure

I ran across this article (“Protect and Value the Truth”) about a wonderful talk by author Chimamanda Ngozi Adichie. Here are my favorite quotations from her that are given in the article. I separated them by added bullets:

  • It is hard to tell ourselves the truth about our failures, our fragilities, our uncertainties. It is hard to tell ourselves that maybe we haven’t done the best that we can. It is hard to tell ourselves the truth of our emotions, that maybe what we feel is hurt rather than anger, that maybe it is time to close the chapter of a relationship and walk away. And yet, when we do, we are the better off for it.

  • Be courageous enough to say ‘I don’t know … Ignorance acknowledged is an opportunity; ignorance denied is a closed door. And it takes courage to admit to the truth of what you do not know.

  • You cannot create anything of value without both self-doubt and self-belief. Without self-doubt, you become complacent; without self-belief, you cannot succeed.

  • Your story does not have to have a traditional arc.

Donald Yacovone: How Ubiquitous History Textbooks Taught White Supremacy →

The details in the book excerpt linked to above are telling.

One very troubling idea, but one that might have too much truth to it, is that an outgroup is necessary to generate unity in an ingroup. Donald Yacovone asserts:

… if no slaves ever existed in the South, Northern white theorists, religious leaders, intellectuals, writers, educators, politicians, and lawyers would have invented a lesser race (which is what happened) to build white democratic solidarity, and in that way make democratic culture and political institutions possible. As one of our greatest authors, Toni Morrison, once explained, in the United States the rights of man were “inevitably yoked to Africanism.” In other words, American democracy depended on Black inequality to sustain white equality.

Jonathan Haidt talks about “groupishness” as one mode of being human. Groupishness makes us act very well towards the ingroup and badly toward the outgroup:

As Rob Henderson says, "A psychopath is a person who treats their ingroup the same way that normal people treat their outgroup."

I hope that having an outgroup is only a shortcut to getting ingroup solidarity and not an absolute necessity. It may require an advance in social cohesion technology to have any better way.

Current Information Provision is Inadequate: Let's Put Salient Warnings on Alcoholic Beverages

Alcohol causes health harms of the same order of magnitude as tobacco, but health warnings on alcohol are much less salient than those on tobacco. It is past time to rectify that. The New England Journal of Medicine “Perspective” piece shown above has useful points to make. Here are some passages, separated by added bullets:

  • … alcohol consumption now accounts for more than 140,000 deaths per year in the United States, or more than 380 deaths per day. The Covid-19 pandemic has exacerbated alcohol-associated harm in the United States, with alcohol-related deaths increasing by 25% during the first year of the pandemic as compared with the previous year.

  • In addition to the data on fatal and nonfatal injuries resulting from acute intoxication (including injuries caused by motor vehicle crashes), mounting research links longer-term alcohol consumption to chronic diseases including hypertensive heart disease, cirrhosis, and several types of cancer.2 Even light or moderate drinking increases the risk of these conditions, particularly cancer.2

  • Warning labels are most effective when they are displayed prominently on the front of product packaging, include pictorial elements such as photographs or icons, and rotate the content of their messages to avoid any one message becoming “stale.” A randomized trial involving 2149 smokers, for example, found that large, front-of-pack, pictorial warning labels for cigarettes increased smoking quit rates by 50% (from 3.8 to 5.7%) over 4 weeks as compared with smaller, side-of-pack, text-only warning labels.4 Similar benefits have been documented in longitudinal studies examining smoking behaviors after countries implemented well-designed cigarette-package warning labels and in quasi-experiments evaluating grocery purchases after implementation of prominent front-of-package warning labels for unhealthy foods and beverages.

  • The current alcohol warning in the United States lacks all the key elements of evidence-based warning design: it uses small text, typically appears on the back or side of product packaging, and doesn’t include any pictorial elements (see figure). The warning message is also static, having remained unchanged since the label was first implemented more than three decades ago.

  • … when large, pictorial warnings about cancer risk were temporarily added to the front of alcohol containers in some stores in Yukon, Canada, alcohol sales dropped by 6 to 10%.5

The pleasing idea that a little alcohol is good for health has done a lot to maintain a positive image for alcohol. Unfortunately, that idea is false. I lay out one of the most telling pieces of evidence damning alcohol in “Data on Asian Genes that Discourage Alcohol Consumption Explode the Myth that a Little Alcohol is Good for your Health.”

Warnings are likely to substantially reduce alcohol consumption. And we should not stop there. It would help protect people if every instance of alcohol consumption was considered an indulgence and social disapproval of more than minimal alcohol consumption gradually increased.

How a Toolkit Lacking a Full Strength Negative Interest Rate Option Led to the Current Inflationary Surge

In the third part of our April 7, 2022 “The Future of Inflation” trilogy, “The Electronic Money Standard and the Possibility of a Zero Inflation Target,” Ruchir Agarwal and I write:

Despite the surge in inflation worldwide, central banks have been behind the curve in raising rates. One reason is the reliance on forward guidance instead of negative interest rate policy. At the onset of the COVID-19 crisis, most advanced country central banks lowered their rates to the effective lower bound (but not deeper into negative territory) and thus had to deploy ‘forward guidance’—by committing to maintain the near-zero rates until they were confident that the economy was on track to achieve employment targets. However, such forward guidance tied the hands of several central banks when faced with rising inflation—leading to a sluggish interest response to record-high inflation. Tying their hands with a forward guidance promise was especially unfortunate given the unprecedented nature of the shock.

And for Mitra Kalita’s August 9, 2022 newsletter post “We're Asking the Wrong Question About the Recession,” I crafted two unused quotes (quoting from my email to her):

  • Because raising rates too late means it is typically necessary to engineer a recession to bring down inflation, the Fed, in effect, caused the coming recession by failing to take decisive action earlier. What might decisive action earlier have looked like? Instead of waiting to raise rates until April 2022 and starting slowly, the Fed should have raised rates by 3/4 of a percentage point in December 2021 and announced that it would keep raising rates by 3/4 of a percentage point at each meeting until it saw clear signs that inflation was headed back all the way to the 2 % target rate. The Fed had enough information by its December 14-15 meeting to make that call.

  • Thinking falsely that it couldn't fall back on negative rates, the Fed was too slow and timid in raising rates for fear that it didn't have the firepower to quickly reverse a recession if it went too far in raising rates.

Now in his August 26, 2022 Wall Street Journal essay “Can Central Banks Maintain Their Autonomy?” I see that Nick Timiraos, the doyen of monetary policy journalists, takes a similar view of why the Fed and other central banks were behind the curve in raising rates. He writes:

Finally, the pandemic struck just as U.S. and European central bankers were concluding reviews of the policy frameworks they had used to address the problems bedeviling their economies since the 2008 crisis. They wanted to avoid a rut of slow growth and low inflation that would cripple their ability to stimulate the economy in a downturn. They had seen Japan struggle to escape that trap for most of the previous two decades, even after cutting interest rates to zero or below.

At Jackson Hole in 2020, Mr. Powell unveiled an overhauled policy framework. The Fed would aim to return inflation not just to its 2% target but rather to a level a bit above it, so inflation would average 2% over time. For the preceding decade, “We could not get inflation up to 2%,” said Fed governor Christopher Waller. “This sounds crazy. I used to always joke, ‘Go get the guys from Argentina. They know how to do it.’”

Part of the reason Fed officials waited too long to react to the recent surge in inflation is that “they wanted to be sure” that the problem of weak growth and inflation had been vanquished, said Mr. Rajan. “Imagine the hue and cry,” he added, “if they had raised rates immediately: ‘Why are you killing a sound economy?’”

This was in part, a matter of generals fighting the last war rather than the war they are in. But it was more than that. If you thought that fighting the war you are in would destroy all of your hardware for fighting a war like the last war, you could be clear about the war you were in and still hesitate to do what would otherwise be called for.

That is where having a full strength negative interest rate policy in reserve could help. If you know you can cut interest rates as much as necessary to quickly end any recession caused by inadequate aggregate demand, then you can raise rates with the confidence you can get back on track if you make a mistake and overdo it. If you are too afraid to overdo interest rate hikes, you are likely to underdo them. That is what happened.

The Fed has had the opposite problem in the past. In his August 25, 2012 Slate piece “We Need Inflation-Tolerance, Not Inflation,” Matt Yglesias writes:

Imagine you’re watching an Olympic-quality archer who’s having a very bad day. You notice that not only is his overall score much worse than he normally does, but all of his arrows are falling lower than the bullseye. You ask him about it and he tells you that his daughter’s been kidnapped, and the kidnapper says he’ll kill the girl if he shoots a single arrow above the bullseye. Now it all makes sense. The archer hasn’t lost his skill. He’s deliberately aiming too low because he has enormous aversion to shooting above the bullseye. If he lost that aversion, his score would improve.

The moral of the story isn’t that shooting too high is a good way to win an archery tournament. To win, you need to hit the bullseye—neither too high nor too low. But if you become strongly averse to shooting too high, that’s going to undermine your ability to hit the bullseye.

That’s the situation I think American monetary policy is in. It’s not that three or four percent inflation is such a wonderful goal. It’s that extreme aversion to three or four percent inflation is causing the Federal Reserve to persistently “shoot too low” in terms of aggregate demand. Ben Bernanke’s acting as if someone’s holding his daughter hostage. Specifically, the reigning dogma is that if inflation were to go from 2 percent to 3 or 4 percent that long-term expectations might become “unanchored” and drift higher and higher, undermining the “hard won gains” of the Volcker years. But there’s no empirical evidence that this is true, and no particularly strong theoretical reason to believe than the worst-case scenario if inflation tolerance goes wrong is worse that the current strategy of grinding the recession out by letting America’s long-term productive capacity collapse.

In the current context, it is easier to think about trying to hit the moving target of the “right” interest rate. But Matt Yglesias is correct that being too afraid of aiming high will make you aim too low. And being too afraid of aiming low will make you aim too high. The Fed and other central banks need to have tools they are confident can do the job in either direction. Then they can immediately take rates to the level that is their best guess of what is right for the battle they are in, knowing they can swiftly pivot if another threat emerges.

Coda: In the first part of our “The Future of Inflation” trilogy, “Will Inflation Remain High?” Ruchir and I write:

While advanced economy central banks may continue to dislike inflation, their current apparent plans—according to their current dot plots (or the equivalent)—may be behind the curve on what would be required to bring inflation back down. Standard Taylor Rule calculations suggest that it could easily take interest rates as high as 7 percent in several countries to bring inflation down.

This is above the level currently expected by markets. Matt Grossman’s August 26, 2022 news article “Bond Yields Inch Higher After Powell Says Fed Will Hold the Line on Inflation,” reports:

Earlier in the summer, market-based forecasts showed that many investors were second-guessing whether the Fed would wind up raising interest rates as much as central bankers have projected.

In late July, the pricing of derivatives called overnight index swaps estimated the Fed’s benchmark rate would peak at around 3.3% in early 2023 before moving lower again.

At the time, that was a much different outlook than the one espoused by Fed officials themselves, who have generally said they expect rates will have to hold steady or climb next year to corral inflation.

In recent sessions, traders’ forecasts have moved closer to the Fed’s. On Friday, derivatives traders were now projecting that rates will rise to nearly 3.8% by the end of the Fed’s May 2023 policy meeting.

3.8% is still a lot lower than the 7% or so I think will be necessary to bring inflation back to the 2% per year target. Since I believe the Fed is committed to getting inflation under control, I predict further market surprises as market participants and the Fed itself realize how high rates need to go.

See also: