Monetary policy and the zero lower bound (ZLB)

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Question 1: Do you agree that it is feasible for the UK authorities to change the monetary system so that materially negative policy interest rates could be safely implemented? (In answering, you may wish to explain your reasons and define your view of 'material')

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Question 2: Do you agree that the benefits of reforming the monetary system to allow materially negative policy interest rates outweigh the possible costs?

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Summary

Does monetary policy really face a zero lower bound or could policy rates be pushed materially below zero per cent? And would the benefits of reforms to achieve negative policy rates outweigh the costs? This column, which reports the views of the leading UK-based macroeconomists, suggests that there is no strong support for reforming the monetary system to allow policy rates to be set at negative levels.

Introduction

Rising concern about the effectiveness of monetary policy at near zero inflation rates has stimulated a debate among economists that challenges conventional thinking about whether interest rates really have a lower bound around zero per cent. A conference on the zero lower bound (ZLB) organised by Imperial College London, the Swiss National Bank and CEPR last month attracted considerable interest.[1] Indeed, some European central banks have policy rates below zero with no apparent adverse consequences.[2] Further along the term structure, J P Morgan estimated earlier this year that more than a more than a quarter ($2 trillion) of the entire market of European bonds now has yields below zero.[3]

In one of its monthly surveys of leading UK-based macroeconomists, the Centre for Macroeconomics (CFM) asked for views of whether materially negative policy rates are really feasible and whether the benefits outweigh the costs of introducing any necessary reforms. This survey period was between the 17th and 20th June and so after the conference.

Background

Prior to the Great Recession, inflation was low and close to official target rates in the advanced economies and so policy rates tended to deviate relatively little from their long-run average. Central banks responded to the large fall in demand in 2008-09 and under-utilised resources by adjusting key policy interest rates to, or very close to, zero. The nominal return from holding cash is zero, as cash is a zero coupon bearer bond issued by the central bank.[5] Therefore, it has generally been accepted that it is difficult for central banks to reduce their policy interest rates much below zero as cash can always be held as an alternative to negative interest rate bearing assets. The implication is that real policy interest rates have been limited to around negative 2-3% since the recession began, while appropriate real policy rates may have been (and may continue to be) significantly more negative.

Can reforms to the monetary system enable materially negative policy interest rates?

Some economists argue that it is perfectly possible to remove the ZLB on monetary policy.[6] One idea is to reduce the importance of cash by withdrawing large bills and replacing them with electronic money, which can pay a negative interest rate.[7] A second proposal, originally made in the early twentieth century by German economist Silvio Gesell, is for cash to be taxed and stamped on payment to generate a negative return and so be distinguished as legal currency. Third, Robert Eisler suggested that the implied fixed exchange rate between deposits and cash of unity could be made variable. Deposit currency would be the numeraire and used for wage and price contracts and could carry a negative yield. The conversion rate of cash into the deposit currency would vary in line with the yield differential.

Others (for example, Hannoun at the Bank for International Settlements, BIS) have questioned the practical feasibility of these changes. First, there may be distributional consequences as savers receive negative returns and the old and poor, who rely more on cash, may be disproportionately affected. Second, the financial system may be exposed to significant losses through defined benefit pensions and guarantees on nominal return contracts. Third, there may simply be too many political obstacles as, for example, electronic money implies tracking people's transactions and the consequent erosion of privacy.

Q1: Do you agree that it is feasible for the UK authorities to change the monetary system so that materially negative policy interest rates could be safely implemented? (In answering, you may wish to explain your reasons and define your view of 'material'.)

A total of 35 economists responded to this question in the CFM survey. Leaving aside those who neither agree nor disagree, only 32% of panellists agree or strongly agree that materially negative policy interest rates could be safely implemented. Where respondents indicate, ‘material’ is mostly taken to mean negative nominal 2-3%, although one respondent suggests negative 5%. Weighting by self-declared confidence in their answers, 29% agree or strongly agree with the proposition.

Of those who agree with the proposition, many point to the negative policy rates in other countries and some argue that there is scope for even further easing. Sushil Wadhwani (Wadhwani Asset Management and former member of the Monetary Policy Committee, MPC) points to the Swiss National Bank's policy rate at 0.75% while they have large denomination bills (CHF1,000 notes) without a stampede into cash. John Driffill (Birkbeck) notes the cost of holding cash in vaults for large banks and suggests negative 2-3% policy rates might be feasible. Ray Barrell (Brunel) suggests that the UK's policy rate could be reduced ‘perhaps as low as negative 1.5% because of the cost of storing cash when the largest note in circulation is £50’.

Among those who disagree, many highlight the uncertainties in the risks and benefits of the necessary reforms. Sir Christopher Pissarides (LSE) notes that there ‘are great advantages to transparency and simplicity’ and changes to accommodate negative interest rates ‘will make both worse’. Patrick Minford (Cardiff Business School) reminds us that ‘cash is a low cost transactions medium, costless to produce and in welfare terms its use should be maximised’. Wouter Den Haan (LSE) notes that money is based on trust, which would be ‘severely negatively affected’ if bank deposits were to have negative interest rates. Angus Armstrong (NIESR) asks what would happen to loans priced as a spread over policy rates and whether zero or negative mortgage rates make sense.

Other respondents note that reforms on the scale suggested would need political support. Sean Holly (Cambridge) indicates that in this context, 'UK authorities' really means Parliament. Dame Kate Barker (Credit Suisse and former MPC member) thinks that while this all may be feasible in theory, in practice ‘it would be rejected by the population’.

Do the benefits outweigh the costs?

There is a healthy debate about the UK’s economic outlook with ever present risks and uncertainty. Since early 2009, the Bank of England's key policy rate has been 0.5% and the average real Bank rate has been negative 2.2%. The MPC has also sanctioned £375 billion of government bond purchases financed by the creation of central bank reserves. According to the December 2017 futures contract, the market expects the Bank rate to be 2% in 17 months from now.

On the other hand, the current expansion has been underway since 2010 and the typical post-war expansion has lasted for seven years (with the exception of the 1992-2008 period). If the economy were to suffer a serious shock and recession before policy interest rates have begun to be normalised, then the ZLB may be a constraint on monetary policy. The apparent lack of monetary options may in fact cause precautionary behaviour and weaken demand. But the changes to the monetary system that would be necessary to allow materially negative policy interest rates and address the concerns mentioned in question 1 would perhaps involve significant transition costs.

Q2: Do you agree that the benefits of reforming the monetary system to allow materially negative policy interest rates outweigh the possible costs?

A total of 38 economists responded to this question in the CFM survey. Leaving aside those who neither agree nor disagree, only 26% of panellists agree or strongly agree that the benefits of reform outweigh the costs. Taking account of self-declared confidence in their answers, only 23% agree or strongly agree with the proposition.

Those who agree that the benefits outweigh the costs of reforms mostly see this as creating policy space for responding to possible future downturns. Michael McMahon (Warwick) notes that real rates have trended down over the last 30 years and that it seems more likely that ‘the ZLB will bind more, and more regularly in future business cycles’. John Driffill thinks that it may be worth having the capacity to introduce ‘some of these ingenious schemes’ should the desired real interest rate become very negative. Sushil Wadhwani suggests that the feasibility of these options should be investigated in the near term as ‘policy-makers need potential ammunition’. Note that the depth of reforms that respondents had in mind when answering this question is unclear.

Martin Ellison (Oxford) disagrees with the proposition, arguing that the costs would fall unevenly across different parts of society. Tony Yates (Birmingham) notes that ‘theoretical research and practical history show that monetary institutions are quite delicate’. Morten Raven (UCL) adds that the impact of such reforms is ‘sensitive to expectations traps – self-fulfilling equilibria in which a wave of pessimism takes the economy into a liquidity trap’.

Mike Wickens (Cardiff and York) cautions that the policy may create hysteresis whereby even a small rise in interest rates would become an important signal leaving ‘monetary policy in the UK paralysed’. Sir Charles Bean (LSE and former Bank of England deputy governor) suggests that we ‘really ought to be looking at ways to raise the equilibrium real interest rate’, such as structural reforms to encourage investment and discourage excess savings elsewhere.

Many of the respondents argue that the costs of removing the ZLB are high relative to other policy measures available. Several suggest raising the inflation target as an alternative and others argue that the correct response is more active fiscal policy if monetary policy is ineffective.

 

References

Eisler, R. (1932) Stable Money: The remedy for the economic world crisis: a programme of financial reconstruction for the international conference 1933; with a preface by Vincent C. Vickers. London: The Search Publishing Co.

Gesell, S. (1916, 1958) The Natural Economic Order, Revised edition. London: Peter Owen, 1958. Originally published as Die natürliche Wirtschaftsordnung durch Freiland und Freigeld. Selbstverlag, Les Hauts Geneveys 1916.

Hannoun, H. (2015) ‘Ultra-low or negative interest rates: what they mean for financial stability and growth’, BIS Speech at Eurofi High-Level Seminar, Riga.

Keynes, J. M. (1936) The General Theory of Employment, Interest and Money, Chapter 23. London: Macmillan.

Kimball, M. (2015) ‘Breaking through the Zero Lower Bound’, mimeo.

 

 

[1] See video presentations of the conference speakers on this website http://www.voxeu.org/content/removing-zero-lower-bound-interest-rates

[2] A number of European central banks have set negative policy interest rates. Denmark and Switzerland have negative 0.75% (central rate) policy interest rates and Sweden's key policy rate is negative 0.35%.

[3] See ‘There are positives to negative yields’, Financial Times, 26 February 2015.

[4] An additional CFM survey on the merits of the pre-referendum rescue package for Greece has been published by in the interim. Full results of the survey with experts’ comments are available at  http://cfmsurvey.org.

[5] The total return from cash also depends positively on a convenience yield and negatively on storage costs. The ZLB would be less binding if total return on cash would be negative.

[6] The most comprehensive references are to be found on Miles Kimball’s blog http://blog.supplysideliberal.com and see also http://ftalphaville.ft.com/2015/01/19/2092852/buiter-the-snb-and-the-effective-lower-bound.

[7] For example, all residents could be given a debit payment card where deposits are held at the central bank and become the new legal tender and where the interest rate would be set by the central bank. 

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How the experts responded

Feasibility of monetary system with negative policy interest rates

Participant Answer Confidence level Comment
Wouter Den Haan London School of Economics Disagree Confident
It might be possible to implement such a system, but I doubt very much it can be implemented safely. Fiat money is build on trust. I would think that this trust would be severely negatively affected if negative policy interest rates could imply negative nominal interest rates on deposits. If the adopted monetary system would be such that nominal interest rates on money balances always remain non-negative then the stability of the financial sector would be at risk. Note that the MPC of the BoE has chosen not to lower Bank rate below 50 basis points, exactly because they thought that doing so would make banks' profit margins too low.
Martin Ellison University of Oxford Strongly Disagree Confident
Changing the monetary system to allow for negative policy rates would take UK monetary policy into unchartered waters, fraught with potential risks. One of the main risks is a loss of control of the monetary base, either because currency has to be abolished (which needs to be done at least with respect to high denomination notes as they otherwise dominate as a store of value) or because of the rise of digital currencies as stores of value and media of exchange, such as Bitcoin. On the latter, the central bank could potentially introduce its own digital currency, but even then fiat would have to be put in place to prevent the rise of competing digital currencies dominating offering non-negative rates. It is likely that mildly negative rates can be sustained due to the inconvenience of holding cash or digital currencies to store value, but anything below about -1% would be problematic.
Jagjit Chadha National Institute of Economic and Social Research Agree Confident
Commercial banks' reserve accounts at the Bank of England are essentially deposits by banks in a sterling current account. Currently, under the quantitative easing regime all of the £300 bn-odd reserves are remunerated at Bank Rate. At present the quantity of these deposits mostly reflects supply-related injections resulting from asset purchases. Prior to the start of QE, the quantity of reserves tended to reflect the demand for reserves and, following appropriate reform, may actually respond in a stabilising manner to negative interest rates. The ECB currently pays a negative interest rate (currently -0.1%) on its deposits and the Bank of England could consider how to introduce negative interest rates on these sterling deposits rather than returning to a form of quantity control.
Paul De Grauwe London School of Economics Disagree Confident
Morten Ravn University College London Neither agree nor disagree Extremely confident
Let me start by saying that if the issue is simply that the zero lower bound on the short term interest rate is preventing policy makers to take the desired policy action, there really is no need to reform monetary policy as fiscal policy can be designed to implement the policy that would have been desired in the absence of this constraint. This can be done through a combination of a small set of fiscal instruments (consumption taxes, import taxes and payroll taxes) resembling implementing a fiscal devaluation. Moreover, there are monetary policy options relating to the choice of instrument that can be considered. Secondly, I find the question slightly confused in the sense that the policies proposed in principle can be implemented. It is in principle possible to circumvent the ZLB by switching to electronic money which allows the monetary authority to charge a negative interest rate. Variations of this are seen already with negative interest on bank reserves. The objections raised are not really about feasibility of such policies but about their desirability. Such objections may indeed be very valid and should be properly scrutinized, but that doesn't mean that the proposals are not feasible. If we stick to feasibility, the proposal of replacing cash with electronic money is perhaps the easier option. Stamping money seems rather costly and impractical while changing the conversion rate between cash and deposits seems less effective unless the liquidity trap is a complete surprise (otherwise households and firms may simply avoid making deposits).
Alan Sutherland University of St. Andrews Disagree Not confident
Christopher Martin University of Bath Agree Very confident
There is no such thing as "the interest rate". There are hundreds of interest rates, all of which, to some degree, depend on the interest rates set by the Central Bank. The Central Bank sets three main interest rates; its'main policy rate, the rate at which it makes short-term loans to commercial banks and the rate it pays on deposits by Commercial Banks (the Deposit Facility rate). This latter rate can be negative: it has been negative in the Eurozone since July 2014. In retrospect, the Deposit Facility rate it should have been negative in the UK and US in 2010-11. That might have enabled a larger impact of QE on the "real economy" by lowering the very large reserve balances accumulated by Commercial Banks at the Central Bank. It is less clear that the Deposit Facility rate should have been negative in the Eurozone at this time as Commercial Banks in the Eurozone then faced more of an existential threat.
Patrick Minford Cardiff Business School Strongly Disagree Very confident
The ideas discussed here to 'remedy' the zero bound imply that it is sufficiently important to justify substantial intervention in currency institutions. I have two strong objections to these ideas. First, the zero bound is a transitory situation which applies only to the risk-free rate of interest on government short term bonds. There is no zero bound on the vast majority of credit instruments used by the private sector; nor has there ever been an episode of it that I am aware of. Monetary policy is capable of affecting the credit rate of interest by open market operations that affect bank reserves. It can also affect the exchange rate. Since the crisis the mechanism via bank reserves and credit expansion has been greatly impeded by draconian new regulation of banks; this was a serious mistake, both because this regulation has been heavy-handed and distortionary and also because it has much impeded the recovery. This view of the economy's operation is backed up by recent Cardiff empirical work on the US ('Monetarism rides again?). A further monetary remedy is to strengthen the usual interest-rate setting rule in normal times. One way to do this is to substitute a nominal GDP or price level target for the inflation target. In the paper above we show this would be highly effective in reducing the number of zero bound episodes and stabilising the economy in spite of their occasional occurrence. Second, the suggestions being made involve some costly interventions in monetary institutions- such as stamping currency. Then paying negative interest rates on bank reserves meets its own zero bound at the cost with which banks can store their cash physically; it just pushes the bound lower. These suggestions have their parallel in the advocacy of 'macro-prudential' policy which too is highly distortionary and also made unnecessary by our ability to use monetary policy remedies. In sum this route involves costs for which since there are direct monetary policy remedies available there is no justification.
Akos Valentinyi University of Manchester Disagree Very confident
To set actual negative policy interest rate, is not that difficult as several of Europe’s central banks have cut key interest rates below zero. The more difficult question is how to do it so that it affects the market rates. Lending rates in the UK for example are significantly affected by regulations. It is unclear to what extent negative policy rate could offset that effect. In addition, some of the proposals that would ensure negative interest rates on deposits, for examples, ignores some of the practicalities of implementation. To introduce negative interest rate on some deposits, would require to inform depositors in advance that the term of their deposit contract changes. This can generate large deposit withdrawals as people would rather hold cash potentially resulting in liquidity problems of banks. This can reduce bank lending even further. In general, central banks can set they key interest rates below zero n an unanticipated way. However, ensuring that negative interest rates are paid on various financial assets, are very hard to achieve in an unanticipated fashion, which can destabilise financial markets.
David Bell University of Stirling Disagree Confident
My response reflects my risk aversion and uncertainty as to how the public would respond to these relatively unconventional policy measures
Wendy Carlin University College London Disagree Not confident
Andrew Scott London Business School Strongly Disagree Extremely confident
Ray Barrell Brunel University London Agree Confident
The policy rate is that at which the Bank of England interacts with the money market, and at the short end that is the equivalent of the deposit rate on bank assets at the Bank. The UK could more easily than other countries have a negative policy rate, perhaps as low as 1.5 per cent, because of the cost of storing cash when the largest note in circulation is £50 (which could easily be withdrawn). However, that may not be low enough for some purposes, and lower rates would require noticeable changes in the transaction mechanism and in the storage of value. Regular re-issuing of notes with a fee for transferring between issues would perhaps be the simplest way to allow for this to happen. An annual exchange of notes with a fee based on the target negative rates could be implemented. Rates could perhaps be as low as -3.0 per cent on deposits. Coin based storage would be expensive, but possible, and this could be limited by swapping to heavier coins. However, there would be cost, efficiency and distributional consequences of such policies.
John Driffill Birkbeck College, University of London Agree Confident
It may be possible for the Bank of England to set interest rates of minus 2 or 3 percent per annum without changing the monetary system. It appears that the cost of holding cash in the vaults for large banks is substantial. I think minus 2 percent p. a. is 'materially negative'.
Ethan Ilzetzki London School of Economics Strongly Disagree Extremely confident
This proposals are ivory tower ideas that should not be attempted. The move to electronic money should occur due to the relative costs and benefits of transacting with these new technologies, not by fiat to allow the central bank to conduct an unconventional policies. Stamping money and the variable exchange rate ideas have enormous transactions costs that would strongly outweigh the benefit of dropping the policy rate by 50 basis points.
Sean Holly Cambridge University Neither agree nor disagree Confident
The `UK authorities’ in this case is not the Bank of England but the executive in Parliament. The obstacles will be political and it is unlikely in the current climate that negative interest rates are necessary. Quite the opposite in fact. The Bank of England, of course, does not have the power to engineer the effective abolition of cash, any more than Congress would allow the Federal Reserve to mess with the currency. The ECB has no such powers under the Maastricht Treaty. A unilateral tax on holding UK currency would not work if we can hold dollars or Euros rather than sterling to finance transactions. The use of negative interest rates may be justified in some circumstances. We ought to think through the possible consequences of negative interest rates and then keep the policy locked away against a serious financial crisis that comes once in three generations. It is only in a very serious crisis that political will can allow such a major reform of the monetary system. The real problem we face now is that we have far too little fiscal or monetary room. We need to get back to an interest rate policy that is broadly neutral, initially in the range of 3 to 5 percent for short term interest rates. There are always far too many reasons for always postponing an increase in interest rates and an exit from QE. Financial Markets do not want higher interest rates and they never will.
Jonathan Portes National Institute of Economic and Social Research Agree Very confident
I think the options described above, as well as the practical examples of Denmark and Switzerland, suggest that (modestly) negative interest rates could be implemented in practice. The objections seem to me to about the potential impact (for example the distributional consequences) rather than the practicalities.
Richard Dennis University of Glasgow Disagree Confident
Michael McMahon University of Warwick Strongly Agree Very confident
There are actually a few ways that central bank could redesign the monetary system such that interest rates of -4,-5, and even more negative rates would be possible. Essentially, the central bank could adjust rates symmetrically above and below zero rather than face the asymmetry that there is now. Each have different practical costs and benefits which need to be explored, but materially negative interest rates of the sort I have described are certainly technically possible.
Sir Christopher... London School of Economics Strongly Disagree Very confident
The system could be very complicated to implement, will confuse many people and will make it easy for many to cheat. There are great advantages to transparency and simplicity in financial systems and changing the monetary system to negative interest rates will make both worse
Sushil Wadhwani Wadhwani Asset Management Agree Confident
Obviously, we have a "live" ,ongoing experiment in Switzerland. The central policy rate is -0.75% and has not caused any stampede into cash as yet despite Switzerland having retained large denomination notes. It would be relatively easy to abolish such notes,and the government could also easily consider capping the degree to which insurance companies are allowed to insure cash.In that situation, it might be possible to take rates down to -125bp.At that level,one suspects that behavioural effects on individuals would be rather larger than what we have seen so far(it is possible that there is a non-linear,behavioural response once individuals have to pay something meaningful to hold bank deposits).Relative to a policy rate of 50bp in the UK, being able to cut rates by 175 bp is material. Clearly, to go beyond this, more radical options would need to be contemplated(including some of those that you mention).However, I think that we would need a full-blown economic crisis to secure the political backing for such more far-reaching changes.
David Cobham Heriot Watt University Strongly Disagree Very confident
Angus Armstrong National Institute of Economic and Social Research Disagree Confident
Scandinavian central banks have shown it is feasible to have marginally negative nominal official rates. However, I am doubtful that 100 basis points off the Bank rate would make such an impact on the UK in the extreme times when this would be relevant. Therefore, I interpret 'materially negative' to be around negative two per cent or so. I am doubtful this could be 'safely implemented'. For example, in the UK home owners would earn money (or cost zero) for a typical floating rate mortgage. For all sorts of political economy reasons property would be a very good store of value (as we repeatedly see by government policy toward housing). Also banks would be paid to borrow from interbank markets and so run mismatched balance sheet positions (to require interbank borrowing). This could raise all sorts of information problems which might affect market liquidity.
Andrew Mountford Royal Holloway Disagree Not confident at all
Any policy is subject to people changing their behavior to get around it and so with radical new interventions it's not clear what is feasible/possible or what the costs are -(unknown unknowns etc...). However, that said, it seems to me that if you think that the economy's problems are caused by an inability to impose a negative real rate of interest then why not raise the price level by imposing a steadily increasing sales tax on all goods? The revenue raised could be redistributed so that the poorest are made no worse off. If the remaining revenue was spent on making society more productive (infrastructure, education, housing) then the marginal product of capital wouldn't remain low for long and interest rates should rise.
Charles Nolan University of Glasgow Neither agree nor disagree Confident
Whilst probably feasible, there are likely to be more efficacious ways to intervene and boost nominal spending should the need arise. Various programmes of QE have, overall, proven effective lately. Using the tax and benefit system to boost consumption and expenditure is also likely preferable in the scenario envisaged--assuming that the authorities are prepared to act via such channels.
Tony Yates University of Birmingham Agree Confident
I agree it's feasible. We know what to do and how to do it. I'm less confident that it can be done 'safely' as I explain in my answers to the next question.
Francesco Caselli London School of Economics No opinion Confident
Costas Milas University of Liverpool Disagree Confident
Jan Eeckhout University College London Disagree Not confident
Kate Barker British Coal Staff Superannuation Scheme Disagree Confident
Feasible in theory. But in practice think this would be rejected by the population.
Panicos Demetriades University of Leicester Strongly Disagree Extremely confident
Any proposal to tax holdings of cash is, at best, impractical. Even if it can be implemented, which is very doubtful, it would lead to confusion, inefficiency and currency substitution. It would undermine the foundations upon which modern exchange economies function, namely the existence of a stable and simple to use medium of exchange.
Michael Wickens Cardiff Business School & University of York Agree Extremely confident
Negative nominal rates are clearly feasible. But as they are also distortionary if the real rate of discount is non-negative, they are not desirable and will not be feasible for long. Moreover, they do not seem to have proved effective at stimulating credit growth.
David Smith Sunday Times Strongly Disagree Very confident
Marginally negative policy rates are sometimes of use but materially negative rates, of 2%, 3% or more, would lead to significant distortions. Other tools, such as QE or credit easing, are greatly preferable.
Richard Portes London Business School and CEPR Strongly Disagree Extremely confident
All monetary policy has distributional consequences, so that is not an issue. Effects on DB pensions and on existing nominal contracts, including those at Libor + spread, are significant. But the main point is that this proposal is politically not feasible, at least for many years to come. Don't muck about with my money!
Silvana Tenreyro London School of Economics Agree Confident
Negative policy rates could be implemented to further stimulate the economy if needed---particularly when the Treasury gives up on its role of implementing counter-cyclical fiscal policy.

Desirability of monetary system with negative policy interest rates

Participant Answer Confidence level Comment
Wouter Den Haan London School of Economics Disagree Confident
I would think that in most deep recessions in which one might consider negative policy rates, consumers and firms would care more about job security (consumers) and demand for their products (firms) than the cost of financing durable purchases and investment. This may be different if policy rates are substantially negative (say 5%), but such extreme values are likely to have other undesirable side affects.
Martin Ellison University of Oxford Strongly Disagree Very confident
There are likely to be significant costs to changing the system to allow for negative policy rates, even such a change was feasible. First up, whilst the share of cash in transactions has already fallen to about half, there is considerable heterogeneity in the use of cash across different parts of the population. Part of this in generational, with my daughter almost never using cash for any payments whilst I still use cash for small to medium sized transactions. The subset of the population accustomed to using cash regularly would suffer disproportionate costs from the withdrawal of currency. Secondly, any transition to a new regime would need to be managed carefully so as not to endanger the reputation of the monetary authority. The Bank of England is already running unconventional policies on an unprecedented scale, so adding another untried and untested policy measure is questionable at this time. It would be better to fully explore the consequences and limits of Quantitative Easing before engaging in reform of the monetary system.
Jagjit Chadha National Institute of Economic and Social Research Neither agree nor disagree Very confident
Even if something is feasible it may not be the best thing to do. We have a number of alternatives to negative interest rates per se: asset purchases, signalling about the stance of policy with forward guidance and even managed depreciation of the exchange rate. To some extent the zero lower bound as a return to cash will always offer an alternative to negative returns on electronic money. So I am not sure we necessarily need to move to a regime that encompassed negative interest rates but would certainly encourage any work that spelled out the options.
Morten Ravn University College London Neither agree nor disagree Very confident
Desirability is clearly the big question. As stated above, in principle there are fiscal policy options that should be considered as well. But, let's forget about those as they are apparently not to be considered. The answer to whether the benefits outweigh the costs depend crucially on the design of the policy. Some early proposals related to the inflation target. The argument was that a higher target makes a liquidity trap less likely. This might be correct. However, it comes at the cost of higher inflation when the ZLB does not bind PLUS at the cost of inducing a worse crisis when the ZLB DOES bind. Whether these two costs outweigh the benefits is an empirical question which remains to be answered. Another factor that has to be considered is the impact of the reform on the likelihood of which the economy is sensitive to expectations traps - self-fulfilling equilibria in which a wave of pessimism takes the economy in to a liquidity trap. some of the proposals may indeed leave the economy just as viable - or even more - to such expectational traps as the current monetary arrangement. At the end, I think a serious quantitative evaluation needs to be done before it can be determined whether costs outweigh benefits or not. Undertaking reform without such a serious evaluation risks implementing welfare detrimental policies.
Paul De Grauwe London School of Economics Disagree Confident
Alan Sutherland University of St. Andrews Disagree Confident
Christopher Martin University of Bath Neither agree nor disagree Not confident at all
These proposals are interesting but implementing them would be a leap in the dark. Would they have been helpful in the darkest moments of the financial crisis? Probably. But other options (eg Deposit Facility rates of say -1% ) are available and better understood. I would be hesitant about using these radical proposals until we have a better understanding of how they would change the monetary and credit mechanisms that modern economies rely on so heavily
Patrick Minford Cardiff Business School Strongly Disagree Very confident
My answer above already basically covers this. Let me add a bit more about the costs of these interventionary ideas. Cash is a low-cost transaction medium, is costless to produce and in welfare terms its use should be maximised- whether to the extent of having negative inflation is still an active debate. These ideas in one way or another push in the opposite direction, making cash costlier to use. As I argue above I believe the right way to proceed is to try to improve our monetary policies while respecting this low-cost role of money and avoiding any but the most basic regulation.
Akos Valentinyi University of Manchester Disagree Very confident
One the one hand, it is unclear how much negative policy rate would help as lending and commercial paper rates are significantly above the zero lower bound. The financial regulatory environment contributes significantly to the high lending rates on which negative policy rate may have little impact. On the other hand, there are nontrivial risks associated with changing to change the monetary system so that can generate negative interest rates. For example, the anticipation of the introduction of negative deposit rate may trigger large deposit withdrawals and lead to cash hoarding which could constraint banks further in lending.
Fabien Postel-Vinay University College London Disagree Not confident
David Bell University of Stirling Neither agree nor disagree Not confident
Again unclear whether negative interest rates would have a positve effect on aggregate demand. We have little understanding as to how this development would affect consumer expectations.
Wendy Carlin University College London Neither agree nor disagree Not confident
Andrew Scott London Business School Agree Confident
Ray Barrell Brunel University London Strongly Disagree Very confident
The need for negative policy rates may be temporary, and hence the benefits may be transitory. The costs of changing the financial system may be noticeable and they are possibly permanent. It is probably best to discuss change, but not implement it. The potential real policy rate depends on a number of factors. It is the rate on an essentially risk free, liquid asset. The policy rate may need to be lowered when the authorities wish to stimulate demand by reducing borrowing rates from banks and others for individuals and firms. There may be other ways for the Bank of England to reduce borrowing rates. There are a number of reasons why risk free rates may currently be temporarily low. When banks (or regulators) increase core capital requirements the wedge between borrowing and deposit rates rises, with higher borrowing rates and lower risk free rates. When market participants perceive a high risk of bank failure, the risk free rate will fall as portfolios change. Bank capital is rising, and perceptions of banking sector risk remain high in Europe. It would be better to deal with these issues, raising risk free rates whilst reducing borrowing rates, before restructuring the financial system. There are also other policy tools available when a recession occurs. More active bank restructuring could help reduce perceived risks of failure, raising risk free rates and reducing borrowing rates. In a recession bank capital requirements could be reduced, with borrowing rates falling. In addition, the Bank could intervene directly in private sector bond and equity markets with special vehicles, reducing borrowing costs to firms in doing so. These are much less costly than cash taxes. There are much better tools available in a recession. Fiscal policy remains available in the UK, and it would be wise to use it if a recession occurred. Taxes could be cut, or spending increased on a temporary basis.
John Driffill Birkbeck College, University of London Agree Confident
It may be worth having the capacity to introduce some of these ingenious schemes, so as to be able to use them should it become necessary, i.e., if the equilibrium real interest rate goes very negative so that even a zero nominal interest rate (or the minus two or three percent per annum that could be achieved without changing the monetary system) leaves actual real rates too high to sustain full employment. It may be better though to engineer a boom and get inflation up to a higher level, so that positive nominal rates still leave the real interest rate low enough. It may be simpler to shift the target inflation rate up from two to four percent per annum. It may be preferable to introduce more radical redistributive polices, put more money into into the hands of the poor, and raise the equilibrium real interest rate that way.
Ethan Ilzetzki London School of Economics Strongly Disagree Extremely confident
It is neither desirable nor necessary to reform payment systems in order to lower interest rates further. The central bank should raise its inflation target to 5% and will gain the ability to lower the real interest rate by 300 basis points below the rates it currently can. There is no evidence that a higher inflation target has any real costs, and many emerging markets have done so successfully.
Sean Holly Cambridge University Neither agree nor disagree Confident
Jonathan Portes National Institute of Economic and Social Research Strongly Agree Very confident
The risk of another financial crisis in the reasonably near future (say 10 years) are not quantifiable, but seem to me significant. While other policy tools are available (fiscal stimulus, quantitative easing, helicopter money) unfortunately governments seem unwilling to make use of them to the extent most economists would recommend. Given these unfortunate political or political economy constraints, there may well be circumstances in which negative interest rates might be a useful policy tool. While there would no doubt be costs in planning now for possible implementation, the very large costs that have resulted from the inadequate/misguided policy response to the last crisis suggest that from an insurance perspective they would be good value for money.
Michael McMahon University of Warwick Agree Very confident
Real interest rates in developed economies have tended to trend down over the last 30 years. Given the established norm of a 2% inflation target, this has meant that interest rates now hover much closer to the zero lower bound than they used to even in relatively neutral economic conditions. Given this, it seems all the more likely that the zero lower bound constraint will bind more and more regularly in future business cycles. One option is to raise inflation targets to push nominal interest rates away from the zero lower bound but to, for example, a 4% inflation target risks losing some of the hard-earned anchoring of inflation expectations. This is particularly likely if, after another 10 years, it is decided that actually a 6% target is suitable. While I am sure that any of the changes implemented would be controversial at the time of implementation, such a change of the system to allow negative real interest rates as a normal policy choice stands more likely to be a one-off change in system. And given the likelihood that monetary policy is constrained by the zero bound more and more often, a single interest rate policy that can set negative interest rates seems more desirable than permanently having central banks conducting large-scale asset purchases (especially if the central bank ends up holding ever larger shares of the pool of government securities).
Richard Dennis University of Glasgow Disagree Not confident
Sir Christopher... London School of Economics Strongly Disagree Very confident
The costs are as I explained in my answer to Q1. The benefits are very small, especially since we have "unconventional" means of achieving the same outcomes as negative interest rates, e.g., QE
Sushil Wadhwani Wadhwani Asset Management Agree Confident
The easy changes to make now are to make the maximum denomination of a note to be no higher than £10.I would also set a maximum cap of the degree to which insurance companies were allowed to provide cover for the theft of cash. I do, though, think that the government should go further,as having an extra tool could be helpful.However, as we know so little about the feasibility of these alternative options, i suggest that Royal Commission to investigate this issue be set up in the very near future. Recessions are difficult to predict and policymakers need potential ammunition.
David Cobham Heriot Watt University Strongly Disagree Very confident
The source of the problem is the prohibition on the use of fiscal policy: relaxing that ban (which cannot be justified by economic theory and is essentially ideological) is the efficient and cost-effective way to deal with existing and any further aggregate demand shortages.
Angus Armstrong National Institute of Economic and Social Research Strongly Disagree Confident
I am sympathetic to the concern around the lack of 'room to manoeuvre' in the event of another serious downturn expressed in the question. However, for the first three years of this recession, even after interest rates were reduced to 0.5 per cent in early 2009, the break down in the transmission mechanism lead to higher borrowing spreads that mitigated the stimulus. Perhaps a better response is to address the banking sector and financial market weakness faster - once total collapse had been averted - and increase the diversity of finance. This is a more direct and better understood response than experimenting with negative rates. I also suspect that innovation would soon offer insurance against 'materially' negative rates and so weaken the degree of stimulus e.g. the use of money market funds with chequing facilities.
Andrew Mountford Royal Holloway Disagree Not confident at all
Any policy is subject to people changing their behavior to get around it and so with radical new interventions it's not clear what is feasible/possible or what the costs are -(unknown unknowns etc...). However, that said, it seems to me that if you think that the economy's problems are caused by an inability to impose a negative real rate of interest then why not raise the price level by imposing a steadily increasing sales tax on all goods? The revenue raised could be redistributed so that the poorest are made no worse off. If the remaining revenue was spent on making society more productive (infrastructure, education, housing) then the marginal product of capital wouldn't remain low for long and interest rates should rise.
Charles Nolan University of Glasgow Disagree Very confident
It's fun, and enlightening, to think through how such a reform would work. But, my worry is that it would just be asking too much of monetary policy. Indeed, at the ZLB the distinction between monetary and fiscal policy becomes ever more indistinct and we ought not ignore the other levers of fiscal policy,
Tony Yates University of Birmingham Disagree Not confident
Although we can explain in a formal setting what reforms would be needed, and the benefits that would accrue to removing the zero bound constraint, I am much less sure that these benefits would actually be realisable in the real world. Theoretical research and practical history shows that monetary institutions are quite delicate. Countries can dollarise quickly if their own central banks debase their currency, for example. It is now a popular meme that money is a kind of trusted illusion. Who knows how that trust would respond to such a radical set of reforms. For this reason, I'm against embarking on them except as an absolute last resort. With conventional fiscal policy still with much room, and unconventional monetary/fiscal policies like credit easing that could be flexed much further, I'd be in favour of trying those if we prove unable to escape the current situation. And as far as a preventative policy for the future goes, I would vote for an increase in the inflation target over reforms to eliminate the zero bound.
Sir Charles Bean London School of Economics Disagree Confident
While the zero lower bound constraint may bite more frequently than we believed likely before the crisis, finding clever ways to loosen the constraint would be to focus on the wrong issue. In particular, making possible even lower real interest rates would increase the risk of financial instability by strengthening the incentive for investors and financial institutions to adopt risky ways of generating higher returns. Instead, we really ought to be looking for ways to raise the equilibrium (or natural) real interest rate, especially through structural interventions that encourage higher investment and discourage excess savings in some countries.
Francesco Caselli London School of Economics Agree Not confident
Costas Milas University of Liverpool Disagree Confident
Jan Eeckhout University College London Neither agree nor disagree Confident
Kate Barker British Coal Staff Superannuation Scheme Strongly Disagree Very confident
i find it hard to think that there are not alternative policies, possibly including fiscal, which would be preferable. There is of course a question raised implicitly here about whether the inflation target is too low.
Panicos Demetriades University of Leicester Strongly Disagree Extremely confident
See my previous comment.
Michael Wickens Cardiff Business School & University of York Disagree Confident
I don't see why the monetary system needs to be reformed to allow negative nominal rates, especially as they are likely to be a short-term measure. They are, however, of very doubtful effectiveness and are unlikely to offset the costs of the distortions they bring to financial markets and savers. If the market chooses negative rates then so be it. Otherwise I would avoid them as a policy measure. The problem is that a hysteresis effect has developed in which the precise level of interest rates is probably of far less importance than the signal that even a small rise in interest rates would give. As a result monetary policy in the UK is paralysed.
John VanReenen London School of Economics Agree Not confident
There needs to be the acceptance that there is a stronger role for fiscal policy when we are near the ZLB. We should also set a higher target rate of inflation at say 4%
David Smith Sunday Times Disagree Confident
In the circumstances of another shock or recession, materially negative interest rates could reduce rather than boost confidence. Even the fact that the authorities were reforming the monetary system to allow for materially negative rates could have a negative effect. Other tools are available.
Silvana Tenreyro London School of Economics Agree Confident
Reforming the monetary system to allow negative policy interest rates will equip the BoE with an additional tool to face potential crises in the future.
Richard Portes London Business School and CEPR Disagree Very confident