9/01/2012

Negative interest rates?: No way is that going to happen

Would you loan someone $100 with the understanding that they will pay you back $95 a year from now?  That would make no sense.  You might as well just keep the $100.

So how do you push interest rates below zero?  Kenneth Garbade, a senior vice president in the Money and Payments Studies Function of the Federal Reserve Bank of New York's Research and Statistics Group, and Jamie McAndrews, an executive vice president and the director of research for the Bank, have this suggestion:
One way to push short-term rates negative would be to charge interest on excess bank reserves. The interest rate paid by the Fed on excess reserves, the so-called IOER, is a benchmark for a wide variety of short-term rates, including rates on Treasury bills, commercial paper, and interbank loans. If the Fed pushes the IOER below zero, other rates are likely to follow. . . .
The notion is that the tax will cause banks to want to quickly loan out the additional money and that this will force interest rates down below the near zero rate that they are now at.  But lower excess reserves mean a higher money multiplier and thus higher inflation.  If this increase is anticipated, nominal and real interest rates would actually rise.  Nominal rates would rise because of the higher inflation rate.  Real interest rates would rise because the government taxes nominal, and not real, returns.

The notion that this policy can increase investment only holds if people are making mistakes, that they think that the real interest rate is lower than it actually is. What this debate shows is how weak the economy is and how few people want to invest.  The government can only get more people to invest if they are making a mistake about what future inflation rates will be.

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2 Comments:

Blogger RS said...

The fed/treasury has short circuited the system and wonders why they lights are out.

Money is created by the government, it flows to the banks, it's marked up a few points and it flows back to government where it disappears into a vast wasteland of unproductive expenditure, leaving little for productive use and no reason for banks to risk it.

Mr Bernanke, YOU have created this monster which you can not even admit exists.

9/01/2012 12:58 PM  
Blogger August said...

Hasn't Japan tried something like this? It seems like the next logical step in central banking silliness. Individual banks don't want to do it, but the incentives of the FED to keep the system running suggests to me they'd try something like this. It would seem (to them) to reduce inflation concerns.

9/05/2012 12:11 PM  

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