Eric Lonergan and Megan Greene: Dual Interest Rates Give Central Banks Limitless Firepower

In my post “Helicopter Drops of Money Are Not the Answer,” I argue against indiscriminate scattershot helicopter drops. There are better policies than that. But measures that are equivalent to tightly targeted helicopter drops to support the banking system and neutralize objections to negative interest rates can be very helpful.

Such targeted helicopter drops are not some pie-in-the-sky notion, they are current policy for many of the central banks that have implemented negative rates: both tiered interest on reserves and below-market lending rates offered by the central bank are examples of such “helicopter drops”—or the economic equivalent—targeted to support the banking system.

Concerns about the banking system are the main theoretical reason to doubt the effectiveness of negative interest rates. But targeted helicopter drops to the banking system such as through tiered interest on reserves or below-market lending rates fully neutralize these concerns. See ““Markus Brunnermeier and Yann Koby's ‘Reversal Interest Rate’” for a discussion of both the concern and its solution.

In “Dual interest rates give central banks limitless fire power” on the VoxEU blog, Eric Lonergan and Megan Greene give an enthusiastic thumbs up to such helicopter drops targeted to the banking system associated with a negative rate policy. They are somewhat less concerned about the cost of such targeted helicopter drops to the central bank’s balance sheet than I am. But what is true is that whatever cost there is to the central bank’s balance sheet, there is a long time deal with that cost. A central bank that can print the kind of money its obligations are denominated in will never face a liquidity crisis. It might not have enough other assets to sell to mop up money and reduce the monetary base, but if it is allowed to pay interest on reserves as high as it wants, it can guarantee that a large fraction of the monetary base stays on the sidelines as excess reserves at the cost of gradually increasing that monetary base by the payment of that interest. Eventually, the central bank might need recapitalization from the fiscal authority, but it can afford to wait for recapitalization through several administrations that choose to ignore the central bank’s being underwater according to the usual accounting schemes for central banks. (Note that the usual accounting schemes for central banks neglect what for any private company would be counted a huge asset: the right to print money.) On this issue of how much in the way of targeted helicopter drops to the banking system a central bank can afford, see my post “Why Central Banks Can Afford to Subsidize the Provision of Zero Rates to Small Household Checking and Savings Accounts.”

Ruchir Agarwal feature a particular version of what I am here calling “targeted helicopter drops to the banking system” in our two IMF Working Papers:

Ruchir Agarwal and Miles Kimball: “Enabling Deep Negative Rates to Fight Recessions: A Guide” (pdf) (or on IMF website)

Ruchir Agarwal and Miles Kimball: “Breaking Through the Zero Lower Bound” (pdf) (or on IMF website)

In general, wealth effects are not a problem for the effectiveness of negative interest rate policy, because lower rates shift the balance of power to borrowers in each borrower-lender relationship; and it is quite rare for the marginal propensity to spend of lender to be higher than the marginal propensity to spend of a borrower. To have a positive effect on aggregate demand it is not necessary for everyone to spend more; it is only necessary for those who spend more to outweigh those that spend less. Thinking about this borrower-lender relationship by borrower-lender relationship, almost all of these pairings will raise spending when the spending of the borrower and lender in the relationship is added together.

There may, however, be a few borrower-lender relationships where the marginal propensity to spend of the lender is greater than the marginal propensity to spend of the borrower. In addition to targeted helicopter drops to support the banking system, these few odd borrower-lender relationships could be candidates for a targeted helicopter drop. What I am emphasizing is that of the few rational (as opposed to irrational freak-out) and principled (as opposed to narrowly self-interested) objections to negative interest rates, most have to do with some kind of wealth effect. Almost all of these wealth effect issues can be addressed by appropriately targeted helicopter drops.

Take a look at In “Dual interest rates give central banks limitless fire power” in the light of what I say here. It is important to understand the potential here.