Y13 extension material - negative interest rates

We will have to look at negative interest rates in more detail in our next section on deflation; you have already identified they exist - 5 years ago they were like sasquatch (bigfoot), i.e. rumoured, discussed and extraordinary, but not under consideration in the mainstream. Now there is widespread discussion about them, they exist in several countries (in Switzerland out as far as 10 years!), countries such as Italy (140% debt-to-GDP ratio) can borrow at negative rates, and they are now considered as a potential tool in many other countries, including the UK. Read more below:

Matt Rognlie on negative interest rates by Tyler Cowen on November 30, 2015

What Lower Bound? Monetary Policy with Negative Interest Rates (Job Market Paper)


Abstract: Policymakers and academics have long maintained that nominal interest rates face a zero lower bound (ZLB), which can only be breached through major institutional changes like the elimination or taxation of paper currency. Recently, several central banks have set interest rates as low as -0.75% without any such changes, suggesting that, in practice, money demand remains finite even at negative nominal rates.


I study optimal monetary policy in this new environment, exploring the central tradeoff: negative rates help stabilize aggregate demand, but at the cost of an inefficient subsidy to paper currency. Near 0%, the first side of this tradeoff dominates, and negative rates are generically optimal whenever output averages below its efficient level.


In a benchmark scenario, breaking the ZLB with negative rates is sufficient to undo most welfare losses relative to the first best. More generally, the gains from negative rates depend inversely on the level and elasticity of currency demand. Credible commitment by the central bank is essential to implementing optimal policy, which backloads the most negative rates.


My results imply that the option to set negative nominal rates lowers the optimal long-run inflation target, and that abolishing paper currency is only optimal when currency demand is highly elastic. The paper is here, and it contains many new analytical points. As you would expect from Matt, it is also extremely well-written.


Here Eric Lonergan criticizes Swiss negative interest rates. On the blog of Miles Kimball, you will find many arguments for negative nominal interest rates, and also the abolition of currency, another topic covered by Matt in his paper.