What's Wrong With Negative Rates?

[MachineGhost]

Finally, someone with two cents of a clue (emphasis added).  This looks paywalled or some sort so here's the full article:

[quote=https://www.project-syndicate.org/comme ... tz-2016-04]
APR 13, 2016
What’s Wrong With Negative Rates?

NEW YORK — I wrote at the beginning of January that economic conditions this year were set to be as weak as in 2015, which was the worst year since the global financial crisis erupted in 2008. And, as has happened repeatedly over the last decade, a few months into the year, others’ more optimistic forecasts are being revised downward.

The underlying problem — which has plagued the global economy since the crisis, but has worsened slightly — is lack of global aggregate demand. Now, in response, the European Central Bank (ECB) has stepped up its stimulus, joining the Bank of Japan and a couple of other central banks in showing that the “zero lower bound” — the inability of interest rates to become negative — is a boundary only in the imagination of conventional economists.

And yet, in none of the economies attempting the unorthodox experiment of negative interest rates has there been a return to growth and full employment. In some cases, the outcome has been unexpected: Some lending rates have actually increased.

It should have been apparent that most central banks’ pre-crisis models — both the formal models and the mental models that guide policymakers’ thinking — were badly wrong. None predicted the crisis; and in very few of these economies has a semblance of full employment been restored. The ECB famously raised interest rates twice in 2011, just as the euro crisis was worsening and unemployment was increasing to double-digit levels, bringing deflation ever closer.

They continued to use the old discredited models, perhaps slightly modified. In these models, the interest rate is the key policy tool, to be dialed up and down to ensure good economic performance. If a positive interest rate doesn’t suffice, then a negative interest rate should do the trick.

It hasn’t. In many economies — including Europe and the United States — real (inflation-adjusted) interest rates have been negative, sometimes as much as -2%. And yet, as real interest rates have fallen, business investment has stagnated. According to the OECD, the percentage of GDP invested in a category that is mostly plant and equipment has fallen in both Europe and the US in recent years. (In the US, it fell from 8.4% in 2000 to 6.8% in 2014; in the EU, it fell from 7.5% to 5.7% over the same period.) Other data provide a similar picture.

Clearly, the idea that large corporations precisely calculate the interest rate at which they are willing to undertake investment — and that they would be willing to undertake a large number of projects if only interest rates were lowered by another 25 basis points — is absurd. More realistically, large corporations are sitting on hundreds of billions of dollars — indeed, trillions if aggregated across the advanced economies — because they already have too much capacity. Why build more simply because the interest rate has moved down a little? The small and medium-size enterprises (SMEs) that are willing to borrow couldn’t get access to credit before the ECB went negative, and they can’t now.

Simply put, most firms — and especially SMEs — can’t borrow easily at the T-bill rate. They don’t borrow on capital markets. They borrow from banks. And there is a large difference (spread) between the interest rates the banks set and the T-bill rate. Moreover, banks ration. They may refuse to lend to some firms. In other cases, they demand collateral (often real estate).

It may come as a shock to non-economists, but banks play no role in the standard economic model that monetary policymakers have used for the last couple of decades. Of course, if there were no banks, there would be no central banks, either; but cognitive dissonance has seldom shaken central bankers’ confidence in their models.

The fact is that the eurozone’s structure and the ECB’s policies have ensured that banks in the underperforming countries, and especially in the crisis countries, are very weak. Deposits have left, and the austerity policies demanded by Germany are prolonging the aggregate-demand shortfall and sustaining high unemployment. In these circumstances, lending is risky, and banks have neither the appetite nor ability to lend, particularly to SMEs (which typically generate the highest number of jobs).

A decrease in the real interest rate — that on government bonds — to -3% or even -4% will make little or no difference. Negative interest rates hurt banks’ balance sheets, with the “wealth effect” on banks overwhelming the small increase in incentives to lend. Unless policymakers are careful, lending rates could increase and credit availability decline.

There are three further problems. First, low interest rates encourage firms to invest in more capital-intensive technologies, resulting in demand for labor falling in the longer term, even as unemployment declines in the short term. Second, older people who depend on interest income, hurt further, cut their consumption more deeply than those who benefit — rich owners of equity — increase theirs, undermining aggregate demand today. Third, the perhaps irrational but widely documented search for yield implies that many investors will shift their portfolios toward riskier assets, exposing the economy to greater financial instability.

What central banks should be doing is focusing on the flow of credit, which means restoring and maintaining local banks’ ability and willingness to lend to SMEs. Instead, throughout the world, central banks have focused on the systemically significant banks, the financial institutions whose excessive risk taking and abusive practices caused the 2008 crisis. But a large number of small banks in the aggregate are systemically significant — especially if one is concerned about restoring investment, employment, and growth.

The big lesson from all of this is captured by the familiar adage, “garbage in, garbage out.” If central banks continue to use the wrong models, they will continue to do the wrong thing.

Of course, even in the best of circumstances, monetary policy’s ability to restore a slumping economy to full employment may be limited. But relying on the wrong model prevents central bankers from contributing what they can — and may even make a bad situation worse.

Joseph E. Stiglitz

Joseph E. Stiglitz, recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979, is University Professor at Columbia University, Co-Chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and Chief Economist of the Roosevelt Institute. A former senior vice president and chief economist of the World Bank and chair of the US president’s Council of Economic Advisers under Bill Clinton, in 2000 he founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. His most recent book is Rewriting the Rules of the American Economy.
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[sophie]

Nice article.

Sounds like the problem with the economic models he's talking about is oversimplification.  There are lots of variables more important than interest rates:  harsher tax and regulatory environment, and stagnation of wages for >90% which means stagnant or falling demand are the big two that come to mind.  No company is going to borrow money to fund expansion when there's no market to expand into, however favorable the rates.

Also, the stock market is showing the effects of interest rates lower than dividend yields, which means it's not at all correlated with the health of the economy, as is also generally assumed.

They'd do better to consider the reasons for wage stagnation & falling demand.  Like maybe globalization and porous borders?  Perhaps there's nothing that can really be done about that now and the process will just have to run to its logical conclusion, but that could well take longer than our respective lifetimes.

[Pointedstick]

They'd do better to consider the reasons for wage stagnation & falling demand.  Like maybe globalization and porous borders?  Perhaps there's nothing that can really be done about that now and the process will just have to run to its logical conclusion, but that could well take longer than our respective lifetimes.

Definitely part of it. Another big one is just… enough. Even for serial over consumers, eventually you either have enough stuff, or you run out of ability to pay for more of it, or justify it to yourself. There are poor people in my town who have two fancy new trucks, but they're not going out of their way to get a third.

[barrett]

They'd do better to consider the reasons for wage stagnation & falling demand.  Like maybe globalization and porous borders?  Perhaps there's nothing that can really be done about that now and the process will just have to run to its logical conclusion, but that could well take longer than our respective lifetimes.

Definitely part of it. Another big one is just… enough. Even for serial over consumers, eventually you either have enough stuff, or you run out of ability to pay for more of it, or justify it to yourself. There are poor people in my town who have two fancy new trucks, but they're not going out of their way to get a third.

Yes, I keep coming back what PS wrote. A big change in my lifetime has been the sheer volume of certain items in our homes. I just counted my pairs of socks and I have 43 (pairs, that is)!!! I keep getting them as gifts and although the quality isn't that high, they're all good enough for something. We do laundry so frequently that I could easily get away with less than ten pairs. Ditto for underwear and T-shirts. But, the point is that I could live another 40 years and probably not need to buy another pair of socks

The standard number of cars here in CT seems to be four. I've seen as many as seven.

[dualstow]

Low interest rates, low consumer spending, and according to the Washington Post last week, lower birth rates. I see more US-Japan comparisons coming soon, and often.

[barrett]

Low interest rates, low consumer spending, and according to the Washington Post last week, lower birth rates. I see more US-Japan comparisons coming soon, and often.

Dualstow, you seem to think that my sock count is not a leading indicator! I am revising it upwards as I just found three pairs in the drier and have another 10 pairs or so in another property (I am not just hoarding clothing items). Closing in on 60!

US demographics - at least when viewed in the total number of humans - would seem to set us apart from Japan just because we still have net population growth due to immigration. But, yes, the similarities seem to be growing.

I do sometimes wonder if the US couldn't just open the immigration spigot to full blast for a few decades to keep overall consumer spending up. It would be a short-term fix but governments seem to like those. Not many countries could absorb another, say, 150 million people so easily, but I think the US probably could.

[MachineGhost]

I do sometimes wonder if the US couldn't just open the immigration spigot to full blast for a few decades to keep overall consumer spending up. It would be a short-term fix but governments seem to like those. Not many countries could absorb another, say, 150 million people so easily, but I think the US probably could.

We could if we also forced them to assimilate, otherwise it would be the death of the USA.  Having giant pockets of non-assimilated foreigners living in the motherland and -- horror of horrors -- BREEDING! is the worst possible outcome for the cultural hegemony of any nation.  That's why the EU is imploding from the forced immigration of the Muslims.

It takes a ridiculous amount of background checking and investigation over 18+ months just to allow Middle Eastern refugees into this country.  That's schizophrenic and a much a higher standard than normal immigration which seems to be porous.  Refugees may not assimilate and may go back to their motherland when it is time, but at least they're self-identified as such.

Japan does go way overboard, though.  Only about 1% of their population consists of foreigners.  And they're excluded from economic opportunities just like Japanese women are.  I think it's much more of a patriarcherical mindset than anything.  I bet some ultraliberal whackjob could argue that the unilateral intervention of the USA in literally shaping and setting up Japan, Inc. post-WWII aborted the "natural process" of women gaining their rights. 

[sophie]

I am revising it upwards as I just found three pairs in the drier and have another 10 pairs or so in another property (I am not just hoarding clothing items). Closing in on 60!

The Barrett Sock Index??

That's an impressive total.  Which goes to show, there's no upper limit on acquisitions!  There's always another iPhone, Xbox, music streaming service, or thingie from Amazon to buy.  And my sister is definitely the Car Acquisition poster child.  She's firmly of the belief that every one of her kids needs a car the moment they get their drivers license.  To be fair, she lives in a rural area where any errand outside the home requires a 45 minute car trip.

I do sometimes wonder if the US couldn't just open the immigration spigot to full blast for a few decades to keep overall consumer spending up. It would be a short-term fix but governments seem to like those. Not many countries could absorb another, say, 150 million people so easily, but I think the US probably could.

The problem with the immigration spigot is that the ones most likely to come won't be able to get anything more than minimum wage jobs, and will be a net money sink due to government services & welfare programs used.  Frankly what they mainly do is hold down wages & prices.  That's what I meant by "run to its logical conclusion":  only when poverty is equalized throughout the Americas will the drain finally stop, or at least slow to a manageable trickle.  That's one big, long deflation we are talking about.

[dualstow]

Socks: tried and failed to come up with a money laundering joke, Barrett.

[MachineGhost]