The zero lower bound and Miles Kimball’s visit

One of my persistent messages on this blog has been that central banks and finance ministries need to be much more pro-active in dealing with the technological and regulatory issues that make the near-zero lower bound a binding constraint on how low policy interest rates can go, and hence on how much support monetary policy can provide in periods of excess capacity (and insufficient demand).

I’ve found it surprising that the central banks and governments of other advanced economies have not done more in this area. In most of these countries, policy interest rates have been at or near what they had treated as lower bounds since 2008/09. A few have been plumbing new depths in the last year or so, but half-heartedly (the negative rates have not applied to all balances at the central bank), and no one is confident that policy interest rates could be taken much below -50bps (or perhaps -75bps) without policy starting to become much less effective. The ability to convert to physical currency without limit is the constraint. There are holding costs to doing so, but for all except day-to-day transactions, the holding costs would be less than the cost of continuing to hold deposits once interest rates get materially negative. For asset managers and pension funds, for example, that shift would look attractive.  I would certainly recommend that the Reserve Bank pension fund (of which I’m an elected trustee) transferred much of its short-term fixed income holdings into cash if the New Zealand OCR looked likely to be negative for any length of time.

I’ve been surprised by the lack of much urgency in grappling with this issue in other countries. I suspect there must have been a sentiment along the lines of “well, getting to zero was a surprise, and inconvenient, but we got through that recession, it is too late to do anything now, and before too long policy rates will be heading back up to more normal levels”.     But they haven’t, despite false starts from several central banks. And each of these countries is exposed to the risk of a new recession, with little or no macroeconomic policy ammunition left in the arsenal. Interest rates can’t be cut, and the political limits to further fiscal stimulus are severe in most advanced countries.

If the rather sluggish reaction of other advanced country central banks (and finance ministries) is a surprise, the lack of any initiative by the New Zealand and Australian authorities is harder to excuse. Neither country hit the zero bound in 2008/09, or in the more recent slowdown (Australian policy rates are now at their lows, and commentators increasingly expect that New Zealand’s soon will be).  The period since 2008/09 should have shown authorities that the zero lower bound is much more of a threat that most of us previously realised (not just, for example, a Japanese oddity). It should have suggested some serious contingency planning – as, for example, the Reserve Bank of New Zealand had done as part of whole of government preparedness for the possibility of a flu pandemic. Both countries have had years to get ready for the possibility of the zero lower bound. It is not as if the experience of the countries who have hit zero is exactly encouraging – slow and weak recoveries and lingering high unemployment.

But neither New Zealand nor Australia appears to have done anything about it. Indeed, in the most recent Reserve Bank of New Zealand Statement of Intent these issues don’t even rate a mention. I’m not suggesting it is the single most urgent or important issue the central banks face. Contingency planning never is, but that does not make doing it any less important. I’m also not suggesting that New Zealand is as badly placed as some – if we were to get to a zero OCR, our yield advantage would disappear and the exchange rate would probably be revisiting the lows last seen in 2000. And we have some more room for fiscal stimulus than some other countries. But no central bank or finance ministry should contemplate with equanimity the exhaustion of monetary policy ammunition.  Nasty shocks are often worse than we allow for.

My prompt for this post is the visit to New Zealand this week of Miles Kimball, Professor of Economics at the University of Michigan (and an interesting blogger across a range of topics). Kimball has probably been the most active figure in exploring and promoting practical ways to deal with the regulatory constraints and administrative practices that make the ZLB a problem. They are all government choices. I’ve linked to some of his work previously. I noticed Kimball’s visit through a flyer for a guest lecture he is giving at Treasury on Friday, on a quite unrelated topic. I presume he will also be spending time at the Reserve Bank, addressing some of the monetary issues. This would seem like a good opportunity for some serious and enterprising journalist to get in touch with Kimball – whether directly, or via the Reserve Bank or Treasury – for an interview on some of his work in this area, and the reaction he is getting as he promotes his ideas, and practical solutions, around the world.

I’ve suggested previously that if our authorities are not willing to start on serious preparations to overcome the ZLB then the Minister should think much more seriously about raising the inflation target. I’d prefer to avoid a higher inflation target – indeed, in the long-run a target centred nearer zero would be good – but current inflation targets (here and abroad) were set before people really appreciated just how much of a constraint the zero lower bound could be. Better to act now so that in any future severe recession there is no question as to ability of the Reserve Bank to cut the OCR just as much as macroeconomic conditions warrant.

Here are some other previous posts where I have touched on ZLB issues:

On the physical currency monopoly, and thus block to innovation, held by central banks.

On a sceptical speech on these issues by a senior Federal Reserve official

8 thoughts on “The zero lower bound and Miles Kimball’s visit

  1. My concerns with lower rates from here and even negative rates are as follows:
    – These low rates are playing havoc with pension funds globally. I understand that they need 7-8% to survive and by some estimates the shortfalls that they face are well into the trillions already. How will negative rates help this dire situation?
    – Lower rates will force a tipping point, in my opinion, where those who invest in govt bonds will realise that they are anything but risk free and there will be a rush for the exits (i.e. into equities, etc). What then for govts?
    – Lower rates since 2008 have done nothing to stimulate economies in any sustainable fashion, other than increase debt. If people have no confidence in the economy then 1% lending rates will achieve no growth because no one will want to borrow money and banks won’t want to lend.

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    • Len, one of the main consequences of the alternative monetary regimes proposed by Miles Kimball, David Beckworth and others is that it would be much less likely that NGDP expectations would fall so far that very low interest rates were required.

      Michael, it’s occurred to me that this issue is related to another bugbear of yours, namely immigration. If the 150,000 target were reduced inflation might fall (unless all those immigrants were somehow preventing a blowout in wages, which I doubt). In the absence of another commodity cycle, it might put pressure on the RB.

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      • Indeed. It is why I wish a more cautious approach to immigration had been adopted several years ago. To cut immigration a lot now would quickly take the OCR near zero. We need to be doing something about the ZLB risk both because there is a chance (perhaps 10-20%) even on current savings/investment imbalances, but would be much more likely to get there if, say, the savings rate increased or the immigration rate was reduced.

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    • Len,

      Debt in most countries has gone sideways since 08 – govt debt/GDP has risen, while private debt has generally fallen a bit (as it has in NZ).

      There is no doubt that changing short-term interest rates doesn’t alter the medium-term prosperity prospects of a country, but it can make quite a difference in the short run. For me, the thought experiment is along the lines of “if the OCR had simply been held at 8.25% since 2008, would the NZ economy be stronger or weaker than it is now”. I’m pretty sure it would have been weaker, and that we’d be grappling with deflation issues now.

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  2. Michael, I would agree this is an important point. What I find strange is that there hasn’t been much effort put into reassessing the performance of inflation targeting in light of the experience of 2007-14. Indeed the most cited article for “inflation targeting reassessment” is Willard 2006. There was an IMF paper in 2010 that said inflation targeting was good, but it didn’t manage to isolate the impact of floating exchange rate regimes which probably drove the result.

    Whereas a layperson’s view as to the effectiveness of inflation targeting must be something like:
    Eurozone: total disaster
    US: disaster until Carney, then OK.
    UK: similar to US.
    Sweden: OK until Swensson was marginalised and forced out, then disaster.
    Japan: never achieved the target, but real economy OK.
    NZ and Australia: OK but not really tested due to high immigration, fiscal stimulus and terms of trade boost.

    Notwithstanding all the bloggers talking about level targeting, NGDI targeting, higher inflation targets, has there been any serious attempt at regime assessment by a central bank or its government?

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  3. Presume your US and UK should be reversed?

    I think the answer to your final question is “not really”. Personally, I’m not convinced that inflation targeting is the problem (altho in principle would probably favour shifting to wage targeting), but equally it is not going to be the “end of [monetary] history” solution. But we (central bankers) just misjudged how much of a risk the ZLB was, and then have refused to do anything about resolving the issue – or seriously discussing whether, as an alternative the inflation target (or wage or NGDP) target should be higher.

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