Narayana Kocherlakota Advocates Negative Interest Rates Now

I think Narayana Kocherlakota is jumping the gun a bit: let’s wait and see what aggregate demand we need once the lockdowns are mostly over. But I am glad to see Narayana Kocherlakota advocating negative interest rates since we might well need them once the lockdowns are over. (See “Why We are Likely to Need Strong Aggregate Demand Stimulus after Tight Social Distancing Restrictions are Over.”) Narayana’s advocacy is noteworthy because he is a former President of the Minneapolis Federal Reserve Bank.

Narayana makes the key arguments for considering negative interest rates as a normal part of the monetary policy toolkit. Quoting him, but adding a bullet for each passage:

  • Why the fear of negative rates? A decade ago, the answer would have been that it was impossible to go below zero: Banks would simply avoid the charges by withdrawing their reserve deposits and holding the funds in paper currency, which pays zero interest. But economists now recognize that doesn’t happen, because it’s costly to store billions (or trillions) of dollars of paper currency safely. Several European central banks, as well as the Bank of Japan, have successfully taken interest rates below zero. 1 This stimulates consumer demand in the usual ways: by incentivizing banks to make loans at lower interest rates, to bid up the prices of financial assets, and to charge higher fees for deposits.

  • Another of the Fed’s concerns about negative rates has to do with financial stability — a relatively new (and completely made up) responsibility of central banks. … But officials worry that they will also weigh on banks’ profitability, pushing down share prices and making the financial system more vulnerable to distress. …

    The Fed is inventing a trade-off where none exists. If the central bank really cares about financial stability, it has many tools to ensure it. Right now, for example, it could block large banks from paying dividends, a practice that erodes the capital they need to absorb losses. None of this precludes a monetary policy focused on the Fed’s congressional mandate of maximizing employment and keeping inflation near target. 

Of course, my favorite part of Narayana’s column is his citation of my IMF Working Paper with Ruchir Agarwal, “Enabling Deep Negative Rates to Fight Recessions: A Guide.” Narayana writes:

Central banks have so far been unable or unwilling to lower interest rates more than a percentage point below zero. But the economists Ruchir Agarwal and Miles Kimball have offered a guide on how they can go further.

“Enabling Deep Negative Rates to Fight Recessions: A Guide” pulls together for an academic and policy audience what I have been writing about on this blog for a while, as you can see from “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” Copy-pasting from that bibliographic post:

If you want academic policy papers, please turn to these three: