Turns out negative rates aren’t exactly new. My good friend David Zervos, chief market strategist for Jefferies & Co., sent out a note this week pointing out that many “real,” inflation-adjusted rates have actually been negative for years. Such rates have thus far not produced the kind of reflation that central banks want to see. David thinks the ECB and BOJ should push nominal rates down to -1%, launch new quantitative easing bond purchases of at least $200 billion per month, and commit to do even more if their economies don’t respond.
Is Zervos losing his mind? No, he actually makes a pretty good case for such a policy – if you buy into his economic theories, which I discuss in the second part of this letter. (Over My Shoulder subscribers can read Zervos’s note here.) It is painfully clear to most of us that what the central banks have done thus far has not worked. I have a hard time imagining that a major NIRP campaign will help, but I’ve been wrong before.
Former Minneapolis Fed President Narayana Kocherlakota, who was for years the FOMC uber-dove, says going negative would be “daring but appropriate.” He has a number of reasons for this stance. In a note last week, he said the federal government is missing a chance to borrow gobs of money at super-attractive interest rates.
Kocherlakota would like to see the Treasury issue as much paper as it takes to drive real rates back above zero. He would use the borrowed money to repair our rickety infrastructure and to stimulate the economy.
It is an appealing idea – in theory. In reality, I have no faith that our political class would spend the cash wisely. More likely, Washington politicians would collude to distribute the money to their cronies, who would build useless highways and bridges to nowhere. The taxpayers would end up stuck with more debt, and our infrastructure would be little better than it is now.
The fact that this is a “monumentally” bad idea doesn’t mean it will never happen. There’s an excellent chance it will happen. Yellen and the Fed are clearly looking in that direction.
Yellen & the Spirit of Prudent Planning
Yellen might face one small problem on the road to NIRP: no one is completely sure if the Fed has legal authority to enact such a policy. An Aug. 5, 2010, staff memo says that the law authorizing the Fed to pay interest on excess reserves may not give it authority to charge interest.
This potential snag is interesting for a couple of reasons. With last month’s release of this memo, we now know the Fed was actively considering NIRP less than a year after Bernanke himself said publicly that “no one will lend at a negative interest rate.” Meanwhile, some at the Fed were clearly examining the possibility.
What else was happening at the time? The bond-buying program we now call QE1 had just wrapped up in June 2010. The Fed launched QE2 in November 2010. This memo came about because the Fed realized it needed to do more and was considering options. QE2 apparently beat out NIRP as the crazy policy du jour.