Narayana Kocherlakota Argues That Negative Interest Rates Should Be Seen as Part of Conventional Monetary Policy

My first economic journal article on negative interest rate policy is entitled “Negative Interest Rate Policy as Conventional Monetary Policy.” So it is delightful to see Narayana Kocherlakota arguing that negative interest rate policy should be treated as conventional monetary policy in his post “The Potential Power of Negative Nominal Interest Rates.” Here is the heart of Narayana’s argument: 

Here’s the wrong way to communicate: keep saying that negative is a purely emergency setting that will be abandoned shortly.  The impact of policy depends on the expected path of interest rates over the medium and longer term.   The central bank’s communication means that its expanded policy space will have little influence on those medium and longer term expectations.   Note that even if the central bank actually keeps rates negative for many years, this ongoing communication will systematically rob the policy of its effectiveness (as well as hurting central bank credibility).

Here’s the right way to communicate: keep saying that all available tools, including negative interest rates, will be used as is needed to return employment and inflation to desirable levels as rapidly as possible.   This communication means that the public and markets know that the new policy space can be used to buffer the economy against any adverse shock.

I agree with everything above. But part of the reason Narayana argues this way is that he thinks there is some limit below which interest rates cannot go, because of paper currency. But the paper currency problem is well on its way to being solved. (See How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.”) For any central bank that knows what it is doing, there is no lower bound to interest rates other than the risk of overheating the economy by too much monetary stimulus.And increasingly, central banks do know how to break through any lower bound created by paper currency. In particular, I have personally explained how to deal with the paper currency problem in the following presentations (a list copied over from “Electronic Money: The Powerpoint File” as of today):

  • Bank of England, May 20, 2013
  • Bank of Japan, June 18, 2013
  • Keio University, June 21, 2013
  • Japan’s Ministry of Finance, June 24, 2013
  • University of Copenhagen, September 5, 2013
  • National Bank of Denmark, September 6, 2013
  • Ecole Polytechnique (Paris), September 10, 2013
  • Paris School of Economics, September 12, 2013
  • Banque de France, September 13, 2013
  • Federal Reserve Board, November 1, 2013
  • US Treasury, May 19, 2014
  • European Central Bank, July 7, 2014
  • Bundesbank, July 8, 2014
  • Bank of Italy, July 11, 2014
  • Swiss National Bank, July 15, 2014
  • Society for the Advancement of Economic Theory Conference in Tokyo, August 20, 2014
  • Princeton University, October 13, 2014
  • Federal Reserve Bank of New York, October 15, 2014
  • New York University, October 17, 2014
  • European University Institute (Florence), October 29, 2014
  • Qatar Central Bank and Texas A&M University at Qatar joint seminar, November 17, 2014
  • International Monetary Fund, May 4, 2015
  • London conference on “Removing the Zero Lower Bound on Interest Rates” sponsored by the Imperial College Business School, the Brevan Howard Centre for Financial Analysis, the Centre for Economic Policy Research (CEPR) and the Swiss National Bank, panel on Economics, Financial, Legal and Practical Issues, May 18, 2015
  • Bank of England: Keynote Address for “Chief Economists’ Workshop– The Future of Money,” May 19, 2015
  • Bank of Finland, May 20, 2015
  • Sveriges Riksbank, May 21, 2015
  • Uppsala University, May 25, 2015
  • Norges Bank, May 28, 2015
  • Bank of Canada, June 11, 2015
  • Reserve Bank of New Zealand, July 22, 2015
  • New Zealand Treasury, August 5, 2015
  • Lake Forest University, September 1, 2015
  • Federal Reserve Bank of Chicago, September 3, 2015
  • American Economic Association Meetings, San Francisco, January 4, 2016

That won’t be the end of my itinerary.