So much for the zero bound

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.

Update:  Like Tyler Cowen and David Beckworth, I’m skeptical of proposals to eliminate currency.  In order of preference:

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.”


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43 Responses to “So much for the zero bound”

  1. Gravatar of W. Peden W. Peden
    5. June 2014 at 05:49

    Great post.

    As far as I can tell, the only positive thing about the ECB’s appalling performance over the last six years is that we’ve seen a number of liquidity trap myths disproven.

  2. Gravatar of Garrett Garrett
    5. June 2014 at 06:59

    I’d say the most positive thing is that it hasn’t led to war.

  3. Gravatar of multinonde multinonde
    5. June 2014 at 07:00

    Scott,how high would you set the NGDPLT growth rate for a country that still has to do a lot of catch up growth(currently at about 18000 dollars PPP per capita)? How bad would the consequences be if you set the wrong one?

  4. Gravatar of Vaidas Urba Vaidas Urba
    5. June 2014 at 07:39

    Quite a significant change, although it was telegraphed well in advance.

    My preferred framing of current ECB policy is that ECB has got a quasi-PLT regime. Note that the vote was unanimous, which is consistent with Germans supporting price level targeting.

  5. Gravatar of ssumner ssumner
    5. June 2014 at 08:10

    multinonde, At that level I’d say a 5% target would be fine, but the exact amount is much less important than the overall concept to level targeting.

    Vaidas, I hope you are right, but I see little sign of that. They will undershoot for many years.

  6. Gravatar of Peter K. Peter K.
    5. June 2014 at 08:14

    In 2011, fiscal stimulus (or less austerity) would have helped as would have more monetary stimulus. Anything is better than nothing. There is even trade/currency policy. Lower the value of the dollar and boost exports which lowers unemployment and boosts demand.

    Of course there are costs whichever way you go. With more government spending you’ll need more borrowing or taxes in the future. With monetary policy grandma will complain that her savings aren’t earning as much of a return as before. With curency devaluation, trading partners will complain that you’re undercutting their exports.

    @ multinodne -

    How bad are the consequences when you undershoot your inflation target for years and years? Look around, they’re pretty bad.

  7. Gravatar of Peter K. Peter K.
    5. June 2014 at 08:15

    In 2011, fiscal stimulus (or less austerity) would have helped as would have more monetary stimulus. Anything is better than nothing. There is even trade/currency policy. Lower the value of the dollar and boost exports which lowers unemployment and boosts demand.

    Of course there are costs whichever way you go. With more government spending you’ll need more borrowing or taxes in the future. With monetary policy grandma will complain that her savings aren’t earning as much of a return as before. With currency devaluation, trading partners will complain that you’re undercutting their exports.

    @ multinodne -

    How bad are the consequences when you undershoot your inflation target for years and years? Look around, they’re pretty bad.

  8. Gravatar of John Brennan John Brennan
    5. June 2014 at 08:40

    Scott,
    When is your book coming out? It is starting to seem like vapor ware :-). Can’t wait much longer :-)

  9. Gravatar of Major-Freedom Major-Freedom
    5. June 2014 at 08:45

    Sumner:

    “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”

    See that everyone? Rather than address and engage the argument about the interest income of older folks, Sumner instead insinuates that an injustice was had by older folks NOT being sacrificed for the sake of an aggregate output that includes weapons of war and boondoggles, or for the sake of the younger generation who should not have been in those lost jobs in the first place. Or, you don’t even have to view output or employmenypt in that “malinvestment” manner, you could just recognize the divide and conquer, exploitation based political strategy advocated by Sumner.

    He has laid bare for all to see that his worldview is based on collectivism, and sacrificing some for the benefit of others. “Your retirement needed to be harmed, Ethel and Frank, for the sake of the more important things like malinvestment and the younger generation.”

  10. Gravatar of Vaidas Urba Vaidas Urba
    5. June 2014 at 08:54

    I still think the general mood is too pessimistic. If 3 year LTROs saved the Eurozone from the inevitable disintegration, maybe 4 year TLTROs which were announced today will succeed in accelerating the recovery?

  11. Gravatar of Joe C Joe C
    5. June 2014 at 09:30

    Major Freedom –

    You should engage the whole argument yourself.

    Sumner:
    “but for 5 years I’ve been saying that if you want higher interest rates then you need to cut interest rates.”

    Seems to me Sumner is actually advocating for older folks.

  12. Gravatar of Doug M Doug M
    5. June 2014 at 09:49

    I remember talking to a EuroDollar trader in the 90s about negative rates in the context of Japan, which makes me think that the subject must have been in the academic paperwork by that time.

  13. Gravatar of LK Beland LK Beland
    5. June 2014 at 09:54

    The idea that central bank must keep interest rates high to protect savers seems quite strange to me.

    In my mind, passive income is the fruit of the labor being applied to the capital one has rented out. If there is a demand shortfall leading to less labor being performed with that capital throughout the economy, it naturally follows that the former level of passive income will no longer be sustainable. Less labor means less wealth is created and less interest can be paid.

    If the demand shortfall is fixed and production is at full capacity, there will be more wealth available to pay interest.

    I understand there are other effects at hand, but I fail to see how having idle labor will enrich savers in the long run.

  14. Gravatar of maynardGkeynes maynardGkeynes
    5. June 2014 at 09:57

    If this means German savers are going to be charged for keeping their money in a bank, I see a populist revolt. I can’t see this flying politically in Germany, and I’m surprised Merkel signed off on it.

  15. Gravatar of Major-Freedom Major-Freedom
    5. June 2014 at 10:15

    Joe C:

    I don’t accept contradictions. It is absurd to say that to have higher rates, we need lower rates, or vice versa.

    It would be like saying to cure people, we first have to make everyone sick.

  16. Gravatar of Michael Byrnes Michael Byrnes
    5. June 2014 at 10:54

    Major wrote:

    “I don’t accept contradictions. It is absurd to say that to have higher rates, we need lower rates, or vice versa.

    It would be like saying to cure people, we first have to make everyone sick.”

    No. It’s more like orbital mechanics. To speed up, you must reverse thrust.

  17. Gravatar of Steven Kopits Steven Kopits
    5. June 2014 at 11:53

    “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.”

    This requires some explanation. This assertion seems to posit a “hair trigger” theory of interest rate sensitivity. Will an increase of 25 basis points normally send an economy into a recession? If so, will a decline of 25 basis cause a recovery? Is every movement of such size associated with a recession or recovery? Or is it an asymmetric threshold? Why?

    If ordinary sensitivity is not 0.25%, under what circumstances does the “hair trigger” come into play? How do we know if we’re at the trigger threshold?

  18. Gravatar of Benny Lava Benny Lava
    5. June 2014 at 12:22

    I’m not surprised to see Major Freedom doesn’t believe in modern medicine either. Ever heard of chemotherapy? You’re probably one of those colloidal silver guys.

  19. Gravatar of Doug M Doug M
    5. June 2014 at 12:23

    Maynard G Keynes,

    “If this means German savers are going to be charged for keeping their money in a bank, I see a populist revolt.”

    Lots of people pay to keep their money in the bank. In the olden days it used to be justified on the idea that they were keeping your money in a safer place than you could otherwise find to keep it.
    In the modern world, banks charge a variety of service fees for letting the bank hold your money.

    But, in principle here, the central bank would charge the the member banks to hold reserves. The member banks would still earn interest for monies that they have lent out. So, the bank is still making money off of deposits, though perhaps a little bit less than the did last week. To the degree that they choose to pass on those costs to their customers us up to the bank.

  20. Gravatar of Benny Lava Benny Lava
    5. June 2014 at 12:27

    It is funny how these debates go. One can end up opposing Japan’s policies for managing their economy through ministries like export and encouraging keiretsu to succeed zaibatsu. And then turn around and praise Japan’s policies for deflation. Lord knows I’m guilty of some of this too. But at least it was a learning experience. I can say I’ve changed. Can you?

    Can we predict that EU growth will increase and unemployment will decrease? Make this all sciencey?

  21. Gravatar of flow5 flow5
    5. June 2014 at 12:46

    The money supply can never be managed by any attempt to control the cost of credit. Keynes’s liquidity preference curve (demand for money) is a false doctrine.

  22. Gravatar of flow5 flow5
    5. June 2014 at 12:49

    Cumulative monetary flows (our means-of-payment money times its transactions rate-of-turnover), are not increasing, they have been decreasing. The 24 month moving average (of the 24 month roc), shows this.

    Bonds prices can become both cheap & expensive -depending upon how long they move in the same direction (up or down).

    Rates-of-change in money flows mirror the CPI which peaked in Sept 2011 @ 0.039 and has been falling ever since (now @ 0.013). Using a 6 month moving average for the CPI, it shows a clear & steady downward trend.

    parse: dt, NSA cpi, yoy cpi, 6 month moving average NSA cpi

    06/1/2012 ,,,,,,, 0.026
    07/1/2012 ,,,,,,, 0.024
    08/1/2012 ,,,,,,, 0.021
    09/1/2012 ,,,,,,, 0.019
    10/1/2012 ,,,,,,, 0.018
    11/1/2012 ,,,,,,, 0.018
    12/1/2012 ,,,,,,, 0.018
    01/1/2013 ,,,,,,, 0.018
    02/1/2013 ,,,,,,, 0.018
    03/1/2013 ,,,,,,, 0.019
    04/1/2013 ,,,,,,, 0.018
    05/1/2013 ,,,,,,, 0.016
    06/1/2013 ,,,,,,, 0.015
    07/1/2013 ,,,,,,, 0.015
    08/1/2013 ,,,,,,, 0.016
    09/1/2013 ,,,,,,, 0.015
    10/1/2013 ,,,,,,, 0.015
    11/1/2013 ,,,,,,, 0.015
    12/1/2013 ,,,,,,, 0.014
    01/1/2014 ,,,,,,, 0.014
    02/1/2014 ,,,,,,, 0.013
    03/1/2014 ,,,,,,, 0.013
    04/1/2014 ,,,,,,, 0.013

    The cpi is falling. QE3 has failed.

  23. Gravatar of AbsoluteZero AbsoluteZero
    5. June 2014 at 13:40

    Scott, this might be a silly question. Why are the items labeled 1, 2, 2, 3, 4. Just wondering if it’s intentional and there’s some significance I’m missing.

  24. Gravatar of Edward Edward
    5. June 2014 at 13:54

    Major freedom is for sacrificing the young to protect a “guaranteed” rate of return for older savers: risk free of course on the older savers part.

    There is another word for this: it’s called welfare. You don’t even have to delve into the absurd self contradictory nonsense of Austrian capital theory, you just have to realize that MF and his “ilk” (that lunatic you referenced, Benny Lava) are for welfare for savers.

    Pathetic

  25. Gravatar of Kailer Mullet Kailer Mullet
    5. June 2014 at 14:25

    On the low interest rate for savers point, it would seem Mario Draghi agrees with you. From the press conference:

    “So it’s completely wrong to suggest that we want to expropriate savers. Our package of measures actually means exactly the opposite. It’s meant to restore growth, to promote the recovery. And this will allow interest rates to return to a higher level.”

    http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html

  26. Gravatar of John Thacker John Thacker
    5. June 2014 at 14:29

    Scott:

    Is it reasonable to say: “Stop paying interest on (excess) reserves is #0 on your list?” It seems like that could be accomplished before going negative.

  27. Gravatar of Libertaer Libertaer
    5. June 2014 at 15:04

    Oh boy, what a day, what a day… Here in Germany people are running amok, they are FURIOUS! Literally foaming at the mouth! SPIEGEL online, the biggest online news site, had the title: “The End of Capitalism”. If you ran around, telling people you thought Draghi should have done more, you had a decent chance to get killed. It’s that bad!

    I think I never said a good word about Draghi and I’m by no means satisfied by his actions, but today, by making all these idiots suffer, Draghi made my day. And his best line at the press conference was: “We are not finished yet.”

  28. Gravatar of Tom Brown Tom Brown
    5. June 2014 at 15:25

    Libertaer, please don’t take offense but the thought of furious Germans running amok terrifies me… especially in regard to political developments in Greece and Hungary. Unfortunately it sounds like there’s a conservation of European fury here… either Germans on one hand, or Greeks/Hungarians on the other.

    As John Oliver pointed out the other day, political fury in Europe tends to coincide with an invasion of Belgium.

    http://www.thecommentator.com/system/articles/inner_pictures/000/003/974/thumb/Golden_Dawn.png?1374576839

  29. Gravatar of TravisV TravisV
    5. June 2014 at 18:47

    Noah Smith:

    “We don’t know why recessions or inflations happen”

    http://www.bloombergview.com/articles/2014-06-05/what-happens-when-the-economy-baffles-economists

  30. Gravatar of ssumner ssumner
    5. June 2014 at 18:53

    Peter, Even Krugman says fiscal stimulus doesn’t help when not at the zero bound. So how is it possible that fiscal stimulus would help when the ECB is raising interest rates? That makes no sense.

    John, You are sick of waiting? Imagine how I feel!

    Vaidas, I hope you are right, but resolving a debt crisis is very different from boosting AD.

    Doug, You are probably right, but I can’t find anything.

    Steven, I’d rather not talk about interest rates at all, which are not a reliable indicator. NGDP tells you whether money is easy or tight. But commenters keep asking for “concrete steppes” so I oblige.

    Absolute zero, Alzheimers.

    John, Yes.

    Thanks Libertaer.

  31. Gravatar of Vaidas Urba Vaidas Urba
    5. June 2014 at 23:07

    Scott, the original 3year LTRO has boosted AD vs counterfactual, and it has helped with the debt crisis as a result.

  32. Gravatar of Daniel Daniel
    6. June 2014 at 00:53

    Noah Smith is a political operative. He pretty much admitted that on his own blog, in a now-deleted comment.

  33. Gravatar of ssumner ssumner
    6. June 2014 at 04:54

    Vaidas, Even if you are correct, it doesn’t address my point. Why not assume it will again raise growth vs the counterfactual, but growth will remain very sluggish?

  34. Gravatar of Vaidas Urba Vaidas Urba
    6. June 2014 at 07:23

    Scott, it is possible that growth will remain very sluggish, however in this case ECB’s reaction function will call for further easing.

  35. Gravatar of flow5 flow5
    6. June 2014 at 08:13

    Negative deposit charges on IBDDs (or remunerating reserves), are proof positive that most economists don’t understand money & central banking. Changing the rates on IBDDs is not going to change business’s & consumer’s balance sheets (& their demand for loan-funds). And it’s likely to affect non-bank lending/investing (the risk takers), before it affects the commercial banks.

    It’s the individual CBs that create new money & credit (whenever they lend or invest with the non-bank public). And the creation of this new money increases aggregate monetary purchasing power & thereby nominal-gDp. But purchases & sales (POMOs), between the Reserve bank & the CBs are just asset swaps.

    As the federal gov’t is now the largest credit worthy borrower (with the biggest borrowing requirements), then incentives should be concentrated on making enough T-bills available for the CBs to purchase in the secondary market from non-bank customers (in order to arrest any deflationary forces). That is, substitute an “operation twist” for gov’t debt issuance (true Keynesian “pump priming”).

    This was how the CBs operated between 1942 & 2008 (prior to the payment of interest on excess reserve balances), i.e., the CBs minimized their non-earning assets by buying short-term securities & increasing their liquidity reserves (e.g., to offset the onset of bad debt during recessions). But with T-bills yielding less than the remuneration rate, the CBs will obviously choose to hold more, higher yielding, less risky, assets – IBDDs.

  36. Gravatar of Tom Brown Tom Brown
    6. June 2014 at 11:48

    “It would be like saying to cure people, we first have to make everyone sick.”

    That’s kind of how a vaccination works, right? You give people a mild case of cow pox to vaccinate them for small pox, etc.

    It’s also how you move an inverted pendulum which is balanced in the upright position. If you want to move it to the right, you first move the cart it’s balanced on to the left… and then as the pendulum starts to fall to the right THEN you move your cart to the right to catch up with it and overtake it and thus rebalance it.

    Here’s the triple inverted pendulum case, which appears to add another bit complication: first left, then right, then left again:

    https://www.youtube.com/watch?v=Ep2lNMic_fk

  37. Gravatar of Major-Freedom Major-Freedom
    6. June 2014 at 15:04

    Edward:

    You have a mentality that human life is inherently one of sacrificing some people for the sake of others, i.e. that life is a zero sum game.

    Thus, you cannot help but interpret a statement that group A should not be sacrificed for the sake of group B, to be another way of saying that the person really wants group B to be sacrificed for the sake of group A.

    What is pathetic is your depraved and sickening view of human life. You cannot even fathom HOW it can be a world where neither A nor B are sacrificed for the sake of the other.

    The fact that you actually just sanctioned, without even realizing it, that Sumner is calling for old people to be sacrificed for the sake of the younger, is all the point I actually wanted to make. Thank you for verifying it and agreeing with it.

    Oh, and you have not SHOWN how Austrian capital theory is “self-contradictory.” In fact, you have not even shown you understand Austrian capital theory.

    Tom,

    People voluntarily taking vaccinations is not some people making others sick. It is a person agreeing to receive a controlled dosage in order to prevent them from getting sick. I understand the argument you’re drawing on here, and as it stands I won’t disagree with it. But you might want to know that I don’t view interest rates being lowered by central banks to be akin to cures, or vaccinations, or medicine. I consider it to be poison that might make people feel good for a while, but it is a destructive action that makes people worse off than they otherwise would have been, in the future. E.g. 2008 was a future from prior years of poison.

  38. Gravatar of TallDave TallDave
    6. June 2014 at 20:27

    An interesting natural experiment.

    and that the ECB is likely to undershoot its 1.9% inflation target for the next few years.

    The notion that monetary policy can be loose with <2% inflation seems untenable, barring a deep contraction.

  39. Gravatar of Daniel Daniel
    6. June 2014 at 23:58

    Love it how Major_Moron engages in mental contortions to justify a policy that results in the involuntary unemployment of millions (with its subsequent political ramifications – eg, the rise of political extremists).

    Autistic sadistic morons, that’s the austrian school.

  40. Gravatar of ssumner ssumner
    8. June 2014 at 05:13

    Vaidas, I worry that the ECB doesn’t know how to ease policy. Or even how to recognize easy policy.

  41. Gravatar of Larry Larry
    8. June 2014 at 12:59

    Here’s a fun chart.
    http://www.nytimes.com/2014/06/08/opinion/sunday/the-biology-of-risk.html

  42. Gravatar of ssumner ssumner
    9. June 2014 at 04:58

    Larry, Love that stock market graph, with no log scale. Doesn’t the NYT use editors?

  43. Gravatar of Major-Freedom Major-Freedom
    11. June 2014 at 16:39

    Daniel:

    You’re now resorting to fear mongering.

    Yes, I understand that our abusers growing up, and your clearly substandard teachers, have made it difficult for you to deal with the world without abject terror and feelings of helplessness.

    People like you would have said that ending slavery is evil because it would suddenly thrust millions into having to find jobs, because of the “political ramifications”.

    Your assumption that inflation is needed for full employment is false, by the way.

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