Ben Bernanke: Negative Interest Rates are Better than a Higher Inflation Target

Link to “Modifying the Fed’s policy framework: Does a higher inflation target beat negative interest rates?” on Ben Bernanke’s blog

It is clear from Ben Bernanke’s September 13, 2016 blog post, that his answer to his title, “Does a higher inflation target beat negative interest rates?” is “No.” This is not a ringing endorsement of negative rates by Ben, but it is a recognition of the importance of negative rates as part of the monetary policy toolkit. And Ben is quite forthright in naming names of other central bankers he thinks have too negative a view of negative rates. 

Ben links to my paper with Ruchir Agarwal, “Breaking Through the Zero Lower Bound” in this passage:

… it is not clear that an inflation target as high as 4 percent would be politically tenable and hence credible in the U.S. or other advanced economies, whereas arguably feasible institutional changes, some as simple as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates.

Ben also says this in a footnote:

[3] The Fed could also encourage banks (or provide incentives for them) to pass on the negative rates to market-sensitive investors rather than retail depositors, as described here by Miles Kimball, a negative-rates proponent. For more on Miles’ overall argument, see here.

Let me expand on that footnote. I have advocated arranging part of the multi-tier interest on reserves formula to kill two birds with one stone: not only support bank profits but also subsidize zero interest rates in small household accounts at the same time–the provision of which is an important part of the drag on bank profits as it is now. I think being able to tell the public that no one with a modest household account would face negative rates in their checking or saving account would help nip in the bud some of the political cost to central banks.

To avoid misunderstanding, it is worth spelling out a little more this idea of using a tiered interest on reserves formula to subsidize provision of zero interest in small household checking and savings accounts. To make it manageable, I would make the reporting by banks entirely voluntary. The banks need to get their customers to sign a form (maybe online) designating that bank as their primary bank and giving an ID number (like a social security number) to avoid double-dipping. In addition to shielding most people from negative rates in their checking and savings accounts, this policy also has the advantage of setting down a marker so that it is easier for banks to explain, say, that amounts above $1500 average monthly balance in an individual checking+saving accounts or a $3000 average monthly balance in joint couple checking+saving accounts would be subject to negative interest rates. That is, the policy is designed to avoid pass-through of negative rates to small household accounts but encourage pass-through to large household accounts, in a way that reduces the strain on bank profits.

Comparison to Ben’s March 2016 Post and a December 2015 Interview of Ben by Ezra Klein

Ben also had an earlier March 18, 2016 post about negative interest rates: “What tools does the Fed have left? Part 1: Negative interest rates.”  Reading the two posts back to back, it is clear that Ben has warmed up to negative interest rates in the six months from March 2016 to September 2016. Nevertheless, even back in March, Ben leavened his skepticism about negative rates with these two passages:

1. The idea of negative interest rates strikes many people as odd. Economists are less put off by it, perhaps because they are used to dealing with “real” (or inflation-adjusted) interest rates, which are often negative. Since the real interest rate is the sticker-price (nominal) interest rate minus inflation, it’s negative whenever inflation exceeds the nominal rate. Figure 1 shows the real fed funds rate from 1954 to the present, with gray bars marking recessions.[3] As you can see, the real fed funds rate has been negative fairly often, including most of the period since 2009. (It reached a low of -3.8 percent in September 2011.) Many of these negative spells occurred during periods of recession; this is no accident, since during recessions the Fed typically lowers interest rates, both real and nominal, in an effort to spur recovery.

2. The anxiety about negative interest rates seen recently in the media and in markets seems to me to be overdone. Logically, when short-term rates have been cut to zero, modestly negative rates seem a natural continuation; there is no clear discontinuity in the economic and financial effects of, say, a 0.1 percent interest rate and a -0.1 percent rate. Moreover, a negative interest rate on bank reserves does not imply that the most economically relevant rates, like mortgage rates or corporate borrowing rates, would be negative; in the US, they almost certainly would not be.

It is also clear that Ben Bernanke has warmed up to my proposals specifically, if you compare what he wrote in his most recent September 13, 2016 blog post to what he said in part of a December 15, 2015 interview I transcribed in my post “Ezra Klein Interviews Ben Bernanke about Miles Kimball’s Proposal to Eliminate the Zero Lower Bound.”

Though Ben Bernanke is quite cautious about negative rates, I count him now as an ally in the effort to bring them fully into the monetary policy toolkit, with the actual use of negative interest rate tools remaining a very weighty decision.