Interest rate cuts may not be enough

The Fed should certainly cut their target interest rate. But if the coronavirus problem continues to get worse, that may not be enough to keep monetary policy on tract.

A much more effective policy would be to commit to average inflation targeting of 2%/year over the next 5 years. The Fed should indicate that if the coronavirus causes near-term inflation to fall below their 2% target (which is likely), then they’ll go all out to obtain higher inflation in future years, so that 5 years from today the inflation rate will have averaged about 2%.

The goal is to raise the equilibrium interest rate on 5-year Treasuries. Doing so will make monetary policy more expansionary today, for any given setting of the policy rate.

Another advantage of this approach is that the Fed won’t have to backtrack if the coronavirus quickly fades. In contrast, a big cut in interest rates might have to be quickly reversed. There’s actually nothing wrong with quickly reversing an interest rate move as new facts come in, but pundits think it’s embarrassing and hence the Fed is reluctant to “reverse course”. (Of course they aren’t actually reversing course when they cut and then raise rates, as interest rates are not monetary policy.)

PS. Over at Econlog, Steve Fritzinger had a good comment:

My driving policy is to stay 2 to 2.5 seconds behind the car a front of me at all times. To do that speed up and slow down as needed to stay in that window.

If I’m accelerating and decelerating, it doesn’t mean I’ve changed my policy.  It means I’m implementing it.

Here’s another example. My driving policy is to maintain a speed of 65mph. Moving the accelerator pedal as I go up and down hill doesn’t mean I’m changing my policy.



37 Responses to “Interest rate cuts may not be enough”

  1. Gravatar of Michael Rulle Michael Rulle
    25. February 2020 at 10:19

    While they have not said they have a 5 year objective, they have not been able—-or willing——to even keep a 1 year objective. So who is going to believe that—-without a simultaneous immediate action. My unfortunate belief is the Fed will do what it usually does——act too late.

    Now we have Fed’s officially telling us to be afraid of Coronavirus, using the word “inevitable”. Market does not like it. Self fulfilling prophecy moving toward Cowen’s cliff.

  2. Gravatar of ssumner ssumner
    25. February 2020 at 10:32

    Michael, If the Fed misses their 5 year objective by as much as they miss the one year (say 0.4%), it will be a success.

    But yes, they should also take concrete steps.

  3. Gravatar of Scott H. Scott H.
    25. February 2020 at 11:13

    We will maintain 2% inflation over the next 5 years by ___________.

    Am I to understand the blank will be filled entirely with interest rate changes?

  4. Gravatar of Brian Donohue Brian Donohue
    25. February 2020 at 11:25

    “There’s actually nothing wrong with quickly reversing an interest rate move as new facts come in”.

    Amen. Akin to your thought that Fed rates should move daily in step with markets.

    I’m seeing more and more people who understand this. It seems to me the simple version is something like “The US government can borrow at 1.32% over 10 years, why are they borrowing at 1.6% overnight?”

    In the present case, I would expect the reaction to bad virus news is to pile in to cash. Demand for cash is increasing, so the return on cash should decrease, via lower nominal rates, higher inflation, or both. Instead, current Fed policy is encouraging this behavior.

  5. Gravatar of mirai mirai
    25. February 2020 at 12:07

    What do you think about the Brainard’s idea, long-term interest rate target such as the Bank of Japan’s YYC(Yield Curve Control)?

  6. Gravatar of mirai mirai
    25. February 2020 at 12:08

    What do you think about the Brainard’s idea, long-term interest rate target such as the Bank of Japan’s YYC(Yield Curve Control)?

  7. Gravatar of ssumner ssumner
    25. February 2020 at 12:19

    Scott, You asked:

    “Am I to understand the blank will be filled entirely with interest rate changes?”

    No, interest rates are not monetary policy. Once the Fed sets an inflation target, it increases the base enough so that the markets expect them to hit their target. That might require a big increase, or no increase at all. It might even require a decrease in the base. Don’t obsess about concrete steps, that’s missing the bigger issue—the demand for base money when expected inflation is on target is the real issue.

    mirai, It might help a bit, but there are better methods.

  8. Gravatar of Scott H. Scott H.
    25. February 2020 at 12:24

    Scott, to continue then…

    Then you fill in the blank. What I’m asking for seem so simple, yet you seem to be avoiding answering the question. Give me FED actions (beyond interest rates then) that have a causal relationship to manipulating “the base”.

  9. Gravatar of Mike Sandifer Mike Sandifer
    25. February 2020 at 12:57

    Good comments. The Fed may be close to average inflation target policy anyway, so why not start during a crisis?

    Unfortunately, I think they will take the opposite approach and say that now, during a crisis, is not a good time to change regimes. That is, unless things get really, really bad.

  10. Gravatar of Ray Lopez Ray Lopez
    25. February 2020 at 14:00

    @Brian Donohue – “Akin to your thought that Fed rates should move daily in step with markets.” – and what is your alternative? That the Fed leads the market? That would be rather unprecedented. In fact, Brian, and the rest of you guys that would rather not see me post here, and even Scott Sumner, who said he likes me posting here, please name me ONE INSTANCE where the Fed lead the market, and I’ll go away. One instance. I was thinking it might be the famous 1994 Greenspan interest rate rise, which shocked the markets, but then when I researched this I found out actually the markets had anticipated higher inflation and had rose before Greenspan’s move (“Nonetheless, Treasury yields have reversed course and risen sharply since late in 1993 as the bond markets anticipate inflation caused by the booming economy. see: )

    In short, the Fed *follows* the market. Show me one instance to the contrary and I’ll go away.

  11. Gravatar of Brian Donohue Brian Donohue
    25. February 2020 at 14:13


    Between late 2015 and late 2017, the Fed led the market higher, as can be seen by the persistent gap between IOER and 1-month Treasury yields.

    You’re welcome.

  12. Gravatar of Ray Lopez Ray Lopez
    25. February 2020 at 14:19

    @Brian Donohue – IOER was an internal matter between the Fed and member banks, to give them money so they could shore up their balance sheets (in fact, from 2008 until 2012, US banks as a whole were insolvent I’ve read, so IOER was an attempt to increase bank equity). I’m talking about the Fed leading the MARKET, not member banks. Try again. Anybody else?

  13. Gravatar of Mike Sandifer Mike Sandifer
    25. February 2020 at 14:29


    Do you think it’s plausible that raising the Fed Funds rate target, when very near the zero lower bound, can actually be stimulative if r* isn’t too far below r? Can the benefit from greater distance from less effective policy at ZLB overcome tightening effect of r increasing relative to r*?

    I acknowledge that this would not be an issue of the Fed level targeted NGDP.

  14. Gravatar of Christian List Christian List
    25. February 2020 at 15:19

    Didn’t he say that the Fed should move “daily in step with” the markets?

    These are just shorter gaps compared to now. Isn’t the interval currently weeks and months? Why not every day? Why not every minute? Why not “in step with” the markets?

    The Fed is more than welcome to follow. But every day, please. And if needed every hour and every second.

    I have the impression that the Fed is currently acting partly in this way: “Oh, the world is ending. The next meeting was planned for next week. So see you next week.”

  15. Gravatar of Benjamin Cole Benjamin Cole
    25. February 2020 at 16:05

    Stanley Fischer, the former Fed Vice Chair and also the former Governor of the Bank of Israel, advocates that the Federal Reserve have an ability to independently engage in money financed fiscal programs, or helicopter drops.

    I think the tools the Federal Reserve has today, that is interest rates, quantitative easing, and the bully pulpit, are inadequate to the task.

    The federal government can engage in deficit spending but that is a slow and clunky process. Actually, the Federal Reserve strategy of attempting to get commercial banks to lend money, that is create money endogenously, is also a clunky process.

    If there is a large demand swift shock due to the coronavirus, it is clear that the tools that the federal government and the Federal Reserve have today will be very slow in implementation even if they are properly used.

    The fastest way to stimulate the economy would be to implement immediate holidays on payroll taxes. The Federal Reserve can buy Treasuries and place them into the Social Security Insurance Fund to offset the lost tax receipts.

    It makes little sense to worry about long-term inflation targets when the economy is contracting at a 10% annual rate, as may happen in a coronavirus demand crunch (and as happened in the fourth quarter of 2008).

    The Federal Reserve today is allowed to build a balance sheet by buying Treasury Bbonds on global capital markets. This may raise asset values globally but is a weak way to increase aggregate demand within the United States. Is this not obvious? And interest rates have just about played out. One can suggest going to negative interest rates, but that will undercut the very institutions we rely upon to create new money, the commercial banks.

    There is in Western orthodox macroeconomic circles a taboo against money-financed fiscal programs. In the recent past, there was a taboo against quantitative easing, with many historical shrieks that runaway inflation would ensue.

    Different times require different policies.

  16. Gravatar of Benjamin Cole Benjamin Cole
    25. February 2020 at 18:41

    The above paper, co-authored by Stanley Fischer, from BlackRock, the world’s largest money manager, is necessary reading.

    You can send in tweetybirds, or you can send in the helicopters.

  17. Gravatar of Ray Lopez Ray Lopez
    26. February 2020 at 01:02

    @Ben Cole, sometime Thai turkey farmer and paid blogger (how did that failure go?): you do realize that the Fed already did and does ‘helicopter drops’? What do you think the Fed does when it accepts junk paper from member banks? It gives good greenbacks for toxic pieces of paper that say “IOU” backed by assets of dubious value. Why is that so hard to understand? The member banks then use these greenbacks to lend to consumers, or to shore up their balance sheets, and the process repeats. Using fractional reserve banking these greenbacks, of quantity X, can support loans of quantity 1/(1-X), a geometric series summation. You *do* know this right? Or am I going to have to school you like I did Don Geddis?

  18. Gravatar of Benjamin Cole Benjamin Cole
    26. February 2020 at 02:25

    Ray Woepez:

    At least when Scott Sumner insults me, he is on the right playing field, in the right sport.

    You? You are like some guy who says, “As a shortstop, your field goals are way wide of the mark!”

    I went back to bovines and fruit. Some fish.

    I am a failed blogger, and nice of you to point it out.

    However, see this:

  19. Gravatar of Michael Rulle Michael Rulle
    26. February 2020 at 05:25

    Scott must learn to be a better and more clear communicator of his ideas. He needs to remind himself we are not students and there is not that much continuity in a blog as compared to a course——and he needs to be somewhat less mocking of his readers—it may be more fun, but it is less educational.

    For example Scott said “the Fed should cut rates due to the Virus, although it may not be enough to keep monetary policy on track”. A few paragraphs later “Scott says:”interest rates are not monetary policy”.

    Now, I would bet a lot that those two statements are technically accurate—-and I would bet a lot that the normal reader finds those statements contradictory. I assume he means we need to factor in base money——but honestly, I am not sure of that——nor what the Fed needs to do to “do enough”

    And does he mean rates are only part of monetary policy—-or actually not part of monetary policy at all?

    He assumes we should know the answer to my questions. He may be irritated if we don’t ——-worse, he may think we are idiots to ask—since “how many times do I have to tell you morons” —all of which may be also technically true.

    It is his blog—-I like it—-but for the guy who is known to be a leader in Market Monetarism, he should recall the pedagogy of Milton Friedman, who Scott certainly admires greatly. Friedman was a generous and patient guy——at least when communicating

  20. Gravatar of Brian Donohue Brian Donohue
    26. February 2020 at 06:42


    Paying banks IOER is contractionary. Paying 0.5% above market right now is insanity.

    Also, it is helpful to insert the word “taxpayer” in place of “Fed” here to make it clear that this is an ongoing subsidy from taxpayers to banks.

  21. Gravatar of Justin Justin
    26. February 2020 at 07:34

    An Inflation LT is probably the most we can hope for, the Fed just refuses to think in terms of nominal income.

    One thing I worry about is maintaining the balance sheets of households if there’s massive quarantine and furloughs. My understanding is a lot of the Chinese hole up in their flats have had their wages cut. Chinese households maintain large cash emergency funds is my perception, but most Americans do not. Could have a consumer debt crisis in 2020 even if we commit to maintain the price level path over the medium term.

    I’ve thought of different ways to deal with this and they all become too complex. I think the Hong Kong authorities have found a simple, imperfect but realistic solution: give people money.

    Helicopter households money so they can stay on top of their debts.

  22. Gravatar of Justin Justin
    26. February 2020 at 07:43

    One other point the COVID-19 virus brings up is the challenge of forecasting NGDP. Statistical models of the sort I’ve used in the past to do this are probably not going to be effective here.

    Plausible, maybe highly likely, we have horrendous Q2 and Q3 prints, though the current quarter (Q1 2020) could be ok or even ‘great’, as people panic-buy staples (I’ve already done this). By Q4, when the virus is past, we could see massive catch-up growth as people go back to work, but perhaps the damage to the economy will be so bad that it takes into 2021 to have a recovery.

    Anyway, sometime between Q4 2020 and maybe Q3 2021 you could have extraordinary year-over-year NGDP growth…unless the virus becomes a permanent fixture of seasonal life, lose 0.2% of the population every winter. I hope the bat soup was worth it!

  23. Gravatar of ssumner ssumner
    26. February 2020 at 09:55

    Scott H. Open market purchases of bonds.

    Mike, Higher interest rates can reflect either an expansionary or contractionary policy.

    Michael, In the new Keynesian model, the stance of monetary policy is the gap between the policy target and the equilibrium rate. Thus in that model ,”interest rates are not monetary policy”. Instead, the gap between the policy rate and the equilibrium rate is monetary policy. An yet, one might still recommend the Fed cut rates, to narrow that gap.

    And I assure you that you and other long time readers follow what I say more closely than 90% of my students used to (when I taught.)

    Justin, Oddly, the Hypermind markets don’t yet show much impact, but then they’ve always been relatively pessimistic. (And low volume as well.)

  24. Gravatar of Benjamin Cole Benjamin Cole
    26. February 2020 at 10:14

    Justin’s comment above and the real world experiment of a helicopter drop in Hong Kong will be interesting to follow.

  25. Gravatar of Thaomas Thaomas
    26. February 2020 at 10:39

    @ Scott H
    “We will maintain 2% [better, 5% pa increase in the NDGP level] inflation over the next 5 years by ___________.”

    “using any instrument necessary”

  26. Gravatar of Mike Sandifer Mike Sandifer
    26. February 2020 at 12:25


    You replied:

    “Mike, Higher interest rates can reflect either an expansionary or contractionary policy.”

    I find that answer perplexing, since I mentioned raising the Fed Funds rate above the neutral rate.

  27. Gravatar of Mike Sandifer Mike Sandifer
    26. February 2020 at 12:26


    Or actually, I mentioned r being above r*, to be more precise.

  28. Gravatar of Ray Lopez Ray Lopez
    26. February 2020 at 12:46

    @ Ben Cole- I subscribed to your Youtube channel, now there’s five of us, four of which are your relatives. It’s hard to make money in agriculture (or blogging), I’m a gentleman farmer too (in PH and soon in GR) for fun more than profit. Good luck.

    @Brian Donohue – “Paying banks IOER is contractionary” – that’s just a conclusion, and in any event such a supposed ‘contractionary’ policy seems to have not worked, since loans to the private sector have gone up ever since IOER was implemented. Show me where the Fed led the market, that’s what I’m asking for; I posit the Fed follows the market. Analogy: the Fed in theory can tighten or loosen money supply by raising or lowering the reserve ratio (our host can tell us why this is not done more often). But even so, I posit that the market would hardly be affected by such a move, i.e., the Fed is irrelevant. Money is neutral. The natural experiment of the India devaluation of high denomination rupees proved that, as the paper by Amartya Lahiri showed (pace Sumner’s rebuttal).

  29. Gravatar of Christian List Christian List
    26. February 2020 at 13:26

    Hong Kong might be really doing it indeed. Alphaville has already commented on it. They say one doesn’t even know how the money is created and if it really is permanent money creation. They also say Japan has done something similar in the past and that the results have not been breathtaking at that time.

  30. Gravatar of Brian Donohue Brian Donohue
    26. February 2020 at 13:34


    Banks added $200 billion in excess reserves between September and January. Contraction. Stop talking like a sausage.

  31. Gravatar of Ray Lopez Ray Lopez
    26. February 2020 at 13:55

    @BD – never reason from a price change. You still haven’t given me one concrete example where the Fed led the market. Not one. So I’m staying put here, until our host bans me. Catch you on another thread, bye.

  32. Gravatar of Raver Raver
    26. February 2020 at 16:51


    Many of the intellectuals I read and respect, including you, seem to despise Mike Bloomberg, yet I don’t entirely understand why. Can you explain why you don’t like him? Is he worse than Trump?

  33. Gravatar of ssumner ssumner
    27. February 2020 at 09:52

    Mike, The question is not whether r is above r-star, it’s whether r-star is rising at the same time.

    Raver, He’s infinitely better than Trump. But here’s one example of why I don’t like him:

    “From 2002 to 2012, the NYPD made about 440,000 arrests for cannabis possession alone, collectively spending about one million hours processing those cases, according to a report from the Drug Policy Alliance (DPA). Overall, there were more marijuana arrests under Bloomberg than under the mayorships of Ed Koch, David Dinkins and Rudy Giuliani combined.”

    Here’s another:

    “The former New York City mayor prohibited smoking in restaurants and bars, blocked the use of artificial trans fat in restaurants and aggressively pushed for a ban on large sugary drinks, among other public-health measures that were seen by his critics as too far-reaching during his three terms.”

    That doesn’t mean he’d be a bad president, but I don’t like the guy.

  34. Gravatar of Bob Murphy Bob Murphy
    27. February 2020 at 10:46

    Sorry if you’ve addressed this already, Scott, but I don’t see how the coronavirus should affect monetary stance. Isn’t this a supply shift left, so shouldn’t it *increase* prices? Why would a supply disruption make it harder for Fed to hits its CPI inflation target, for example?

    BTW George Selgin had a similar take on Twitter, so this isn’t just goldbug Austrian stuff.

  35. Gravatar of Mike Sandifer Mike Sandifer
    27. February 2020 at 12:47


    Thanks for the clarification. I think this is something I’ve misunderstood about the market monetarist model for quite some time. I was attributing a Keynesian perspective on interest rates to you? And then I often wondered why you tried to avoid the more convenient Keynesian language in your posts. I thought the only problem you had with the Keynesian language was that it focused on interest rates, and many get confused when looking at interest rates. And, of course, interest rates are an effect, not a cause.

    I know you’ve done posts comparing your views to those of Keynesians and New Keynesians, but did you ever do one that covered the differences comprehensively, without assuming some minimum formal macro knowledge?

    I understand it isn’t the purpose of this blog, and you don’t even teach anymore, but there might be substantial interest in such a post, or even a book that goes beyond econ 101, which I took more than 20 years ago.

    I get that the main purpose of the blog is to advocate for better macro policy, but perhaps one way to do that is to better arm the non-economists to push the cause.

  36. Gravatar of Benjamin Cole Benjamin Cole
    27. February 2020 at 16:19

    Some people are saying we will see 0% on US Treasury rates. Of course, 10-year US Treasuries are already at all-time low yields.

    Yes, the Fed could go to negative on IOER. And the Fed could engage in quantitative easing, that’s buying Treasuries, thus lowering rates on Treasuries perhaps by a quarter point, if that.

    Visions of Tiny “the Fed” Tim entering the ring to take on Tyson “Recession” Fury and his trainer coronavirus.

    Read up on Stanley Fischer. The Fed needs the ability to independently implement money-financed fiscal programs.

    The Fed as currently designed and empowered is clunky, slow-footed and weak. Combine that with an inherently fragile commercial banking system. What could go wrong?

  37. Gravatar of ssumner ssumner
    28. February 2020 at 10:34

    Bob, It should not affect the stance of monetary policy. To keep the stance constant, the Fed must cut rates when the equilibrium rate declines.

    Mike, I am working on a book, which I hope comes out next year.

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