When the ECB raised rates from 1.0% to 1.25% in April 2011, the Keynesians told us that Europe was at the zero bound and thus needed fiscal stimulus. When the ECB raised rates from 1.25% to 1.5% in July 2011, driving the eurozone into double-dip recession, they told us that Europe was at the zero bound and thus needed fiscal stimulus. When the ECB later cut rates from 1.5% to 1.25% we were told they were at the zero bound. Ditto for the rate cut to 1.0%, and the rate cut to 0.75%, and the rate cute to 0.5%, and the rate cut to 0.25%, and the rate cut to 0.0%.
And today the ECB has cut rates to negative 0.10%. I guess they are still at the zero bound?
A few observations:
1. The market reaction in both the US and Europe seemed to be mildly positive, although I’d caution you that this move was widely expected, so we don’t really know how much impact it had. My sense is that eurozone policy is still relatively tight in absolute terms, and that the ECB is likely to undershoot its 1.9% inflation target for the next few years.
2. I do feel more confident in predicting that eurozone rates will stay lower for far longer than US rates. There’s an old saying, “if you want peace, prepare for war.” I don’t know about that, but for 5 years I’ve been saying that if you want higher interest rates then you need to cut interest rates. And now the mainstream media seems to finally be catching up. Here’s the FT:
When the governing council of the European Central Bank meets in Frankfurt on Thursday, it is widely expected to announce a loosening in policy – most likely a cut in both the refinancing and deposit rates. Two weeks later, the US Federal Reserve will probably respond to strengthening economic data by moving in the opposite direction, tapering the pace of quantitative easing for the fifth consecutive meeting. This is another sign of how monetary policy is diverging in the two largest economies, a trend that is set to shape funding markets for years to come.
When I advocated easier money in 2011 I was hammered by commenters worried about the interest income of old folks. Well the ECB tried their approach—they raised rates. And as a result the eurozone went back into recession and now faces a Japanese-style situation, near-zero rates as far as the eye can see. Meanwhile the US is planning to start raising rates next year. Just one more example of where us MMs turned out to be right and the conventional wisdom (especially conservative conventional wisdom) was wrong.
2. People used to say the Fed can’t cut rates below 0.25%, for various reasons. I think we now know those were excuses, not reasons.
3. Some people argued that negative rates would be contractionary. The markets don’t seem to think so.
4. My first blog post (after the intro) mentioned negative IOR. I also published articles in January and March 2009 suggesting that negative IOR is an option. At a personal level, I’ve always wondered if I was the first to publish this idea in an economics journal. A New York Fed article from 2009 that explained negative IOR did cite one of my articles. Anyone know of any negative IOR articles before 2009?
Having said that, negative IOR is far from my first best choice. Like Lars Christensen, I prefer NGDPLT, with price level targeting as a second best option. I prefer QE to negative IOR. But I do think it’s better than nothing. There are rumors the ECB plans to do more. Let’s hope so.
PS. Yes, I understand that the zero bound still holds for cash. It would be interesting to see whether the ECB would allow reserve conversion into vault cash as a way of evading the zero bound. My guess is that they’d apply the negative rate to vault cash if the holdings soared beyond a reasonable threshold.
1. A NGDPLT policy at a rate high enough to avoid the zero bound (say 5%.)
2. A big central bank balance sheet, with NGDPLT at a lower growth rate.
3. Negative IOR.
100. Eliminating paper money.
I also agree with Tyler’s claim that the new ECB policy is “not enough.”