To start off with, in this post I won’t be discussing many technical details of negative rates. What this post is about is to approach the topic with care to be sure that apples and oranges don’t cross pollinate each other, and short term nominal rates get conflated with interest paid on reserves.

What is meant by negative rate policy is negative payments, or rather, charging banks to keep excess reserves in their accounts at the Federal Reserve as opposed to paying them interest on those accounts (interest on reserves). It doesn’t mean that the central bank will open up your savings account and drain it.

Why a central bank might want to do negative IoR. If that central bank is like the Fed, and manages the credit channel while holding the base constant, it might want to influence the amount of credit available, and it can do that by adjusting the amount it pays as interest on the reserve accounts of member banks.

An overly simplified explanation of how it works is: if the market rate is lower than the amount paid as interest on reserves, then the level of interest paid on reserves is contractionary. If the market rate is higher than the amount paid on reserves, IoR is expansionary.

But I’d like to introduce a word of caution when thinking about monetary policy in terms of interest rates. There are many kinds of interest rates and discussions about them can become quite conflated and confusing unless they are explicit. Interest rate policy is interest rate policy, credit channel management, not monetary policy in and of itself.

To illustrate the point, the Yellen Fed could tomorrow increase the FF rate by 100 basis points. With that information alone, it would not be indicative of whether monetary policy were tightening or easing because they could also be lowering IoR by 50 basis points and implementing QE of $30Bn per month, trying to hit the inflation target. This is an unlikely example, but it gets to the point pretty clearly.

A cognitive pitfall when consuming media resources on the topic of negative rates is that it should be a necessary element to understand what, if anything, is to be accomplished with them and whether there might be better ways of doing it. I have not seen one article yet describe what the intention of negative rates might be.

One of the problems I see with the entire proposition of the Fed doing negative rates is that nobody understands where the Fed is going. It has an inflation goal, but promises and delivers contractionary monetary policy when that goal in nowhere in sight. And so one needs to have a goal in mind before that possible ‘ah ha’ moment about negative rates could even begin to make sense. At least nobody has been able to convincingly explain to me that some sort of negative rate policy will allow the Fed to hit its inflation target or keep it from missing wide rather than narrow. Where is the golden thread of logic leading us from start to result with one of the Fed critters names on it so we can go back to them later?

The second problem, once one gets the differences between the various interest rates the Fed manages, is that all of them, including management of the FF rate, require understanding of natural rates because management of all of them rely on arbitrage against the level of natural rates in order to achieve the desired effect when one of them is adjusted. Natural rates cannot be directly observed and bad estimates of them produce bad results. Again, nobody has been able to convincingly argue that the Fed has accurate estimates, or anyone there has been held accountable for bad estimates, or that the Fed has the competency to manage the mass of complexity among all of the rates it manages with complete understanding of the ultimate effects. Too many tools that have to work together to do the same thing that simple OMO’s can do gives one a lot of opportunities for error. And the public confusion among the different interest rate tools allows the central bankers to bury mistakes under the complexity so they can point with impunity at housing, or bad banks, or oil for that matter, when the trouble is endogenous to the central bank.

What we desperately need is to stop talking about interest rates and to stop allowing interest rate policy to be conflated with monetary policy. At least the dollar block would be a much happier place with lots more clarity in macroeconomic matters if we did.

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