Academic journal article National Institute Economic Review

Negative Interest Rate Policy as Conventional Monetary Policy

Academic journal article National Institute Economic Review

Negative Interest Rate Policy as Conventional Monetary Policy

Article excerpt

As long as all interest rates move in tandem--including the rate of return on paper currency--economic theory suggests no important difference between interest rate changes in the positive region and interest rate changes in the negative region. Indeed, in standard models, only the real interest rate and spreads between real interest rates matter. Thus, in most respects, negative interest rate policy is conventional. It is only (a) what needs to be done with paper currency, (b) difficulties in understanding negative rates or (c) institutional features interacting with negative rates that make negative interest rate policy unconventional.

Keywords: monetary policy; negative interest rates; unconventional; stabilisation; transmission

JEL Classifications: E52; E58; E42; E43; E41; E31


It took a long time within mathematics for negative numbers to be fully accepted. To this day, negative numbers seem exotic to many people. So it will take a while for people to fully understand negative interest rates. But economic theory makes surprisingly little distinction between positive and negative rates. And the sophisticated business people and financiers who are key to the most important effects of interest rates will grasp the essentials of negative interest rates quickly. (1) Therefore, let me argue on both theoretical grounds and by spelling out some of the practical details that negative interest rate policy will turn out to be a more conventional type of monetary policy than people now realise.

In standard economic models, nominal interest rates don't matter: only real interest rates and the spreads between them matter. The one seeming exception is not an exception at all: the opportunity cost of holding paper currency is closely related to the spread between the real interest rate on, say checking accounts, and the real interest rate on paper currency. Sometimes this equals the nominal interest rate because it has been traditional to have a zero nominal interest rate on paper currency, but it matters in the model because it is the spread between two real interest rates.

This essay is about how best to break with that restrictive tradition and engineer nonzero interest rates on paper currency when needed for economic stabilisation. If central banks take control over the paper currency interest rate, then it is possible to get paper currency out of the way of targeting any real interest rate--even deep negative rates--if necessary for economic stabilisation. But the principles of economic stabilisation and the monetary policy tools needed to achieve it--other than getting paper currency out of the way--are exactly the same as conventional monetary policy before the era of large-scale long-term asset purchases.

Building on Willem Buiter and Nikolaos Panigirtzoglou (2001, 2003) and Buiter (2004, 2007, 2009a,b,c) I have tried to figure out how to free up the paper currency interest rate in a way that is as close as possible to the current system in an effort to minimise the political cost to a central bank of getting paper currency out of the way of interest rate policy. I have taken the resulting specific proposal to on the whole receptive audiences at central banks around the world (listed in updated versions of Kimball, 2013a), and have made efforts to explain such a negative interest rate policy to the general public by blog posts on my blog 'Confessions of a Supply-Side Liberal', articles in online magazines such as Quartz and Slate, and by explaining negative interest rate policy to journalists. The blog posts and online magazine articles have included a children's story (together with amateur rap, operatic, and read-aloud videos dramatising the story), an account of a conversation with my non-economist neighbour about negative interest rates, a quiz, and questions-and-answer posts answering such questions as "Is Electronic Money the Mark of the Beast? …

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