Ryan Avent: What Is Wrong with Central Banks?
Ryan Avent:
Monetary policy: The buck shrinks here: PRIOR to the Great Recession (or, to be perfectly accurate, prior to the Japanese doldrums of the 1990s) there was wide agreement that central banks can, should, and would do all the demand-side macroeconomic stabilisation an economy might need….
But as Japan demonstrated in the late 1990s and as much of the rest of the rich world is learning today, problems can erupt in this system. When the central bank's target interest rate approaches zero, its tried and true policy tool is removed from the arsenal. Central banks appear to be less able to stabilise an economy at the zero bound, a dynamic which generates deep recessions and shallow recoveries…. Yglesias argues that the central bank failure that we observe is primarily technical in nature, and therefore amenable to technological innovation:
Now we come to the miracle of the cashless society…. What if all transactions were electronic, so the only way to avoid keeping money in a negative-rate account was to go out and buy something with the money? Well, then, we would have solved our depression problem. Too much unemployment? Lower interest rates below zero, Americans will start spending and investing again, the economic will grow, and unemployment will go back down to its “natural rate.”…
This could be right, but I think it assumes too much ignorance on the part of central bankers. Ben Bernanke is many things, but dumb is not one of them. Rather, I think that what Mr Yglesias has effectively shown is that problem of the zero bound isn't technical, but political or institutional. Toward the end of his piece, he writes: "Higher inflation in the future is more or less equivalent to a negative interest rate…. But boosting inflation or randomly invalidating currency are bizarre and unpalatable proposals for the economic and political elite. Scrapping cash, on the other hand, is simple and elegant, which is why it will happen some day soon."…
In what way is higher inflation different in its impact on the elite than negative interest rates? One could argue that political backlash is more likely with negative rates; the government has at least a veneer of protection from anger over higher inflation in the form of money illusion. With negative rates, the dynamic would be explicit: the value of the money you have in your saving account is getting smaller, and that is a direct result of government policies. Maybe the citizenry will pull its money out and gleefully go a-spending. Or voters will arm themselves and install Ron Paul as supreme leader….
Zero matters, but not because it imposes a technical constraint. Rather, there is a behavioural constraint. A policy decision in which a central banker must offer households a different (but still positive) rate of return than before seems to be much easier to manage than one in which the policymaker must instead impose a negative rate of return, and whether that loss is due to inflation or a negative nominal rate seems to me to be mostly irrelevant.
