Negative IOR Is An OK Idea, Negative Bond Yields Are A Really Bad Idea

by: Scott Sumner

I find that when things go bad with the economy, the level of discourse seems to suffer. Here are a few items I keep bumping up against:

1. Why not do a helicopter drop? Because there are no free lunches in economics, and any fiscal stimulus will have to be paid for with future distortionary taxes. What if they promise to never remove the money injected in the helicopter drop? Then we either get hyperinflation or perma-deflation, neither of which is appealing. Won't it help to achieve the Fed's inflation target? The Fed already thinks it's achieved its target, in the sense that expected future inflation is 2%, in the Fed's view. That's why they raised rates in December. You and I may not agree, but helicopter drops are a solution for a problem that the Fed doesn't think exists. If we can convince the Fed that market forecasts are superior to Philips curve forecasts, then the solution is not helicopter drops, it's a more expansionary monetary policy.

2. Are negative interest rates good for the economy? That's not even a question. I don't even know what that means. For any given monetary base, lower levels of IOR are expansionary (for NGDP), and lower levels of long term bond yields are contractionary. So there is no point in even talking about whether negative rates are good or bad, unless you are clear as to what sort of interest rate you are discussing.

People often debate whether the problem is that interest rates are too high, or whether the problem is that interest rates are too low. Neither. The problem is that we are discussing interest rates, which means we are talking nonsense. We need to talk about whether NGDP growth expectations are too high or too low. We need to create a NGDP futures market (which I'm trying to do, but not getting much support) and focus on getting that variable right.

Tyler Cowen's recent post on negative rates is not helpful, because it fails to distinguish between the fact that negative bond yields are bad and negative IOR is mildly helpful. The eurozone has negative bond yields because it raised IOR in 2011. That was a really bad move.

3. If market monetarism is so smart, how come you guys can't predict recessions? The point of economics is not to predict recessions (which is impossible, at least for demand-side recessions) the point is to prevent recessions.

4. What's the optimal rate of NGDP growth, or the optimal rate of inflation? It depends. If the central bank plans to hit the target you can get by with a lower growth rate than if they plan to miss the target. If they use level targeting then the optimal growth rate is lower than if they target the growth rate. If capital income taxes are abolished then the optimal rate of inflation/NGDP growth is higher than otherwise. So I can't give you a specific number, except to say "it depends."

5. What do we make of the fact that the yen depreciated when negative IOR was announced, and later appreciated? The depreciation that occurred immediately after the announcement was caused by the negative IOR. The later appreciation was caused by other factors. The EMH says the market responds immediately to new information. BTW, talk about a new headline not matching the accompanying article, check out this bizarre story from Bloomberg.

6. Thomas Piketty recently claimed:

Whatever the case, however, the failures to make such [structural] reforms are not enough to explain the sudden plunge in GDP in the eurozone from 2011 to 2013, even as the US economy was in recovery. There can be no question now that the recovery in Europe was throttled by the attempt to cut deficits too quickly between 2011 and 2013-and particularly by tax hikes that were far too sharp in France. Such application of tight budgetary rules ensured that the eurozone's GDP still, in 2015, hasn't recovered to its 2007 levels.

No question? Anyone making that claim has clearly paid no attention to the recent debate over fiscal and monetary policy. His claim is not just wrong, it's patently absurd. I question the claim. Hence there is a question. QED.

Seriously, Piketty himself points out that the US kept growing during 2011-13. And the US did even more austerity than Europe. And the only significant policy difference was that the US monetary policy was much more expansionary than the eurozone monetary policy. The logical inference is that the eurozone recession was caused by tighter money in Europe. I'm tempted to say that there is "no question" that tight money in Europe caused the double-dip recession, as eurozone fiscal policy was more expansionary than in the US. But I won't, because Piketty clearly questions this claim.

Are there any Keynesians out there who are willing to debate me on this point? I'd love to see the argument as to how fiscal austerity clearly caused a double dip recession in Europe, even though the US did even more austerity and kept growing. It seems to me as if Keynesians live in some sort of intellectual bubble, where they aren't even aware of the arguments made by people on the other side. That's not helpful if you have to debate the other side.