Second thoughts on negative IOR

My very first blog post after the intro discussed negative IOR.  I also published a couple short articles discussing the option in early 2009.  Six years later, what can we say?

1.  I was wrong in assuming the zero lower bound was only 1 or 2 basis points negative.  I made that assumption because in the 1930s and early 1940s T-bill yields never went more than a couple basis points negative.

2.  Being wrong about the zero lower bound made me even righter than I anticipated about the effectiveness of negative IOR.  I argued that people and institutions didn’t particularly want to hold huge amounts of currency, and that assumption was much truer than even I expected.

3.  There was a period where some contrarians were suggesting that negative IOR is a contractionary policy.  I thought that was wrong, as it reduces the demand for the medium of account.  Now I think it’s pretty clear that the contrarian view is wrong.  Negative IOR weakens a currency in the forex market.

4.  Points 1, 2 and 3 seem to make negative IOR a more attractive policy, but if anything my views have evolved in the other direction.  I’d prefer to focus on monetary policy tools like QE and forward guidance, which allow you to exit the zero bound more quickly.  Ultra low rates mean policy has been too tight.

5.  When I originally proposed the idea it was seen as being slightly wacky (even by me.)  Now you have negative yields on 8-year German bonds and 10-year Swiss bonds.  Negative rates are an important part of the modern financial world. Lesson?  Never say never.  NGDP futures might look like a wacky idea today, but back in 2009 the idea of negative yields on 10-year government bonds seemed far, far wackier.  We always need to search for the best options, and let the conventional wisdom catch up when it’s ready.

PS.  Back in early 2009, MMs were the only people saying monetary policy was MUCH too tight.  Matt Yglesias points out that recent events suggest that we were right:

For the USA, the main implication [of negative interest rates] is that back in 2009 and 2010 the Federal Reserve made a mistake. All the objective economic metrics at the time said the “right” interest rate to curb unemployment would be negative. But negative interest rates are impossible! The Fed tried a few tricks to get around that problem, and also told Congress to try fiscal stimulus as a workaround.

The implication of the European experience, however, is that the Fed could have generated negative interest rates through a mix of Quantitative Easing and negative interest rates.



25 Responses to “Second thoughts on negative IOR”

  1. Gravatar of Chuck Chuck
    11. April 2015 at 10:59

    Negative yield were wacky then and are still wacky today.

  2. Gravatar of flow5 flow5
    11. April 2015 at 11:17

    It’s a spurious assumption, that by a Central bank charging for IBDD liabilities, or a commercial bank setting higher customer account and/or transaction fees, these costs will somehow incent new lending/investing, or otherwise spur new spending. Negative interest rates (like the recent rise in bank service charges), decrease money velocity.

    I.e., this environment works in contrast to high interest rates, and expectations of higher prices, which are both a cause and effect of rising rates of Vt.

    And “Negative IOR weakens a currency in the forex market”

    A weak currency is a symptom of a weak, noncompetitive economy. In time a depreciating currency will eliminate the deficit in its balance-of-trade. But the price exacted will be a sharp decline in imports, and the purchase of foreign services, reflecting its relative poverty and inability to compete in the international economy.

  3. Gravatar of bill bill
    11. April 2015 at 11:23

    From the first foot note of the Selgin post you linked to:

    “they (the Fed) did it (IOR) precisely because they didn’t want Quantitative Easing to lead to increased bank lending and, thence, to a general increase in spending.” I added the parentheticals.

    I find that quote so perverse and the best explanation ever for why negative IOR would be stimulative. It’s stunning in fact that they chose to basically sterilize their other actions in this manner.

    I agree with this (of course): “Ultra low rates mean policy has been too tight.” But that’s not an argument against using negative IOR in the present. If our predecessors have left us in a situation (because they were too tight in the past) where we need negative rates to escape, then the sooner we escape, the better. So I’d throw all my tools at it asap. The Fed is too worried about looking like it’s panicked, so it has generally moved too slowly when NGDP growth falters.

  4. Gravatar of bill woolsey bill woolsey
    11. April 2015 at 11:50


    Exactly right.


  5. Gravatar of DanielJ DanielJ
    11. April 2015 at 12:14

    Hey Scott, I’ve been reading your blog since 2009 and really enjoy your take on macro. I’ve recently been working on a decision tree algorithm that attempts to predict changes in NGDP growth. Obviously people have already done this but I find the results to be lackluster. The reason for this in my opinion is the underuse of expectations gauges. I plan on using Expected Nominal Income for Consumers by the Michigan survey along with other variables. My question is, what inputs do you think would have a sufficient predictive power? TIPS spread comes to mind, I would also use M4 divisia, unfortunately it’s so new I can’t use it to “train” the algorithm for old data. Any suggestions or critiques would really be appreciated as I know you’re very busy.

    Daniel Jansen

  6. Gravatar of W. Peden W. Peden
    11. April 2015 at 13:12


    How much divisia data do you need? The Fed publishes data going back to the late 1960s, and IIRC the Center for Financial Stability publishes figures going back neary that far. Further back than that and the Currency in Circulation goes back nearly 100 years and has had about the least unpredictable demand function of any monetary aggregate, though still too unstable to be a main basis of policy, e.g. it corresponds closely over the long run to short-term interest rates-

  7. Gravatar of DanielJ DanielJ
    11. April 2015 at 13:57


    I see what you mean. Although I’m glad to see ample data it presents a headscratcher as I was hoping to avoid using interest rates in the input variables. I wanted to show that expectations parameters can indeed make good predictive inputs into a NGDP rate of growth output. Can you recommend a workaround to this or do you think it is unavoidable.

  8. Gravatar of ssumner ssumner
    11. April 2015 at 14:01

    Bill, Good comment, but I also fear that they might start to rely on negative IOR. As long as the central bank is doing negative IOR, it is doing the wrong policy, even if there are other even more wrong policies that preceded it.

    You need a monetary policy where the equilibrium interest rate is positive.

    Daniel, I really don’t know, but in my view the Hypermind prediction is probably the best we have.

  9. Gravatar of DanielJ DanielJ
    11. April 2015 at 14:02

    Perhaps instead scrap the ‘expectations only’ input scheme and loosen it up. This is by no means publishable worthy work, it’s just a way I’m trying to make a portfolio before graduation. I’ve also considered W/NGDP(t-n), t being defined in quarters and n being a uniform lag associated with the input variables.

  10. Gravatar of DanielJ DanielJ
    11. April 2015 at 14:05

    A lot of this is me remembering different posts you did that used certain normal and synthetic data(W/NGDP) to show what really goes into changing NGDP. At times you stressed expectations as well from the market, however David Beckworth makes really good points on surveys such as Michigan’s. I felt it would be interesting to test all of these theories out in a decision tree. Thanks anyways Scott and best of luck to Hypermind.

  11. Gravatar of benjamin cole benjamin cole
    11. April 2015 at 16:03

    Well, I am proud to say that even among market monetarists I have been on the bullish side, calling for more-aggressive Fed QE and to really blow the doors open.
    I do not think 3 to 4 percent inflation for a couple of yeare is the end of the world as we know it—sheesh, Volcker declared victory when he got inflation down to 5 percent.
    One weakness in policy making is the expectation that inflation will somehow be a.malicious genie that gets out of the bottle or gallops or accelerates or spirals etc.
    I suspect negative interest rates are a weak tool. Banks will not lend to unprofitable propositions. I suspect the Fed should have never given up on QE, but rather expanded the program monthly until results had been obtained for two years.

  12. Gravatar of bill bill
    11. April 2015 at 18:54

    I thought that the Fed paid 0% on reserves for a very long time and that the 0.25% IOR was new in 2008?

  13. Gravatar of Ray Lopez Ray Lopez
    11. April 2015 at 19:46

    I see Sumner deleted my post when he also deleted the Chinese language spam post…oh well, you’ll never know what I said.

    @B. Cole – keep up the good anti-Sumner posting broken record brother, I see you’re such a caricature of a MM that it helps the anti-MM cause.

  14. Gravatar of W. Peden W. Peden
    11. April 2015 at 23:31


    If interest rates are flat, then real money demand is a function of (a) real income, (b) financial innovation, and (c) the price level. So in the US since Q1 2011 the GDP/currency ratio has declined with rising real income at a fairly stable rate, as inflation has been low, there haven’t been innovation shocks to currency demand, and interest rates have been very steady. However, this is an unusual state of affairs, and attempts to pursue demand functions for money with low/zero interest rate elasticity in the late 1950s/1960s did not prosper. I don’t think you’re going to find a model that fruitfully uses money and doesn’t contain interest rates as part of the opportunity cost of the demand function for money.

    On the other hand, we know via the Fisher Effect that interest rates are one of the channels by which expectations affect an economy: if expected inflation rises, then market interest rates will rise as well. So I don’t think that using interest rates is dissonant with an expectations approach. In fact, as I understand it, using interest rate differentials is the traditional way of working out inflation expectations, and it’s all we have once you go beyond periods for which we have inflation survey data and TIPS spreads.

  15. Gravatar of Benjamin Cole Benjamin Cole
    12. April 2015 at 04:05

    Ray Lopez:

    Egads, I think I knew a Ray Lopez at Blair High in 1971. Is that you?

  16. Gravatar of ssumner ssumner
    12. April 2015 at 07:13

    Bill, That’s right.

    Ray, I would never delete any of your posts, they are too entertaining.

    Add paranoia to your other charming qualities.

  17. Gravatar of Ray Lopez Ray Lopez
    12. April 2015 at 07:28

    @Sumner–there was a Chinese character post (Spam) here this morning…somebody deleted it…maybe a ghost. Glad to humor you, if nothing else.

    @Ben Cole – no that’s not me. And I’m not using my real name. OT sad news: feminist economist Barbara Bergmann died today: (Wikipedia): “One of her personal views of economics is “that true anecdotes may well contain more valuable information about the state of things in the world than do economists’ theories, which are by and large nothing but (possibly untrue) stories made up by economists sitting in their offices, with no factual input whatever”.” – sounds like Sumner. How does Sumner justify NGDPLT? From thought experiments in his Ivory Tower. He has no model, no computer simulation, no real world example… but, like the Austrians, he does thought experiments and NGDPLT magically works. The sad thing is, it seems, out of desperation, since people love simplistic solutions, Sumner’s proposals are gaining traction (that’s one reason I’m here, to try and nip them in the bud, but it’s not working is it?). Scott Sumner, the blogger who destroyed the world, LOL, may be his new title someday.

  18. Gravatar of JP Koning JP Koning
    12. April 2015 at 08:26

    “I’d prefer to focus on monetary policy tools like QE and forward guidance, which allow you to exit the zero bound more quickly.”

    Care to flesh this out a bit? Why do negative rates not allow a quick exit?

  19. Gravatar of Cory Hoffman Cory Hoffman
    12. April 2015 at 09:38

    Professor Sumner,

    I attempted to post this question off-topic on your post about California’s water situation but this post seems more appropriate.

    I was wondering about what your thoughts on how the Central Bank should go about setting the Primary Credit Rate/Discount Rate/Overdraft Rate (whatever we want to call it) for providing reserves to member banks as a last resort once we adopt a NGDLT regime?

    When I was searching for posts on this topic I found a post by Bill Woolsey (and you can chime in too if you want Bill) where he recommends 1% above the market-determined fed funds rate:

    “The Fed should announce that as the economy begins to recover, it fully expects all interest rates, including interbank lending rates, to rise substantially from their currently depressed levels. And while closing the discount window would be the first best solution, pegging the primary credit rate at one percent above a market-driven federal funds rate would be a step in the right direction.”

    Seems to me at the very least we have to have the capability for overdraft loans to ensure the integrity of the payment system and 1% above the Fed Funds Rate seems like a good start. Thoughts? Is there any other market driven way that we could arrive at the Overdraft Rate?

  20. Gravatar of DanielJ DanielJ
    12. April 2015 at 14:16

    All excellent points W.Peden. Opening up interest rates to use as an input should make this easier to implement anyhow. I appreciate your help and if I have any more question will post in comments here I suppose. Do you have a blog that I can post in comments in case I have any further theoretical questions?

  21. Gravatar of Donald Pretari Donald Pretari
    12. April 2015 at 16:05

    Prof. Sumner, Perhaps you’ve forgotten our exchange on this post:

    Here, I advocated Negative Interest Rates. It was also one of the first times I commented on your blog. It was also a topic that led to myself and Steve Randy Waldman becoming acquainted. And, lastly, it is the post that I mentioned one of the first people I got to know from commenting on Economic Blogs in 2008:

    “Don, Thanks for the link, I need to link to that blog, as he has the same idea as I do. The FT idea of interest on cash, however, is probably a nonstarter. If I understand your idea, it is for negative rates on T-bills (once nominal rates had fallen to zero.) Is that right? If so, I am afraid that Nick Rowe is right, it wouldn’t work because of private currency hoarding. It is the same logic as my idea, and is a good idea, but here is the difference. The Fed cannot police the public and prevent them from hoarding cash as a way of avoiding negative rates. But the Fed can police commercial banks and prevent them from hoarding vault cash as a way of avoiding the tax on bank reserves.”

  22. Gravatar of Ray Lopez Ray Lopez
    12. April 2015 at 22:39

    @Don Pretari – the silence is deafening, and for Hoffman’s hyper-technical question too. Sumner prefers to beat up on what he perceives as low-hanging fruit (me), which of course back-fires. Your negative interest rate proposal is not believed by Sumner (and he fights hard not to believe it, citing, implausibly, currency hoarding, which only works for people who have no real money. My family has $3M+ in cash–there’s no way we would store this at home in a mattress. And recall the top 1% own nearly 50% of the wealth in the USA), but negative interest has been adopted by Switzerland and the EU central bank, last I read. Sumner believes in ‘sticky wages’, ‘sticky prices’ so in this worldview there’s no room for falling prices or wages, much less falling interest rates.

  23. Gravatar of Donald Pretari Donald Pretari
    13. April 2015 at 06:37

    Ray, Prof. Sumner and I agree on many things, and I wouldn’t have read and commented on his blog since March of 2009 if I didn’t like him and respect him and learn from him. My comment was more in the nature of teasing.

  24. Gravatar of Donald Pretari Donald Pretari
    13. April 2015 at 06:52

    Ray, I’ve also noticed over the years that my comments about other people’s posts are often taken as far more negative than I intended. It must have something to do with belligerent expectations when disagreed with on blogs.

  25. Gravatar of ssumner ssumner
    13. April 2015 at 07:23

    Ray, I have never deleted one of your comments. Perhaps you are delusional too.

    (Lots of comments get automatically blocked for reasons I do not understand.)

    JP, Europe currently has negative rates, and I doubt they will exit early. It’s not that I’m opposed to negative rates, I just think the focus should be on the most effective tools. Interest rates are not an effective monetary policy tool.

    Cory, I’m with Bill. Ideally there’d be no discount window, but his proposal is a good second best.

    Donald, Just to be clear, cash is still the essential problem, it’s just that the storage costs are higher than I anticipated. But of course that strengthened my argument for negative IOR. My point is that it is not a cure-all.

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