Negative Rates Would Have Sped Up Economic Recovery, Fed Paper Says

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02/04/2019 | 10:28 pm

By Michael S. Derby

The Federal Reserve never played the negative interest rate card in response to the financial crisis, but new research claims the economy probably would have recovered faster if it had.

A San Francisco Fed report released Monday says allowing the benchmark federal-funds rate "to drop below zero may have reduced the depth of the recession and enabled the economy to return more quickly to its full potential." The report's authors add that negative rates "may have allowed inflation to rise faster toward the Fed's 2% target."

While some bank accounts offer no returns, others offer a positive interest rate to park money in them. That interest rate is closely related to where the Fed has set its short-term interest-rate target. With a negative interest rate, depositors must pay to keep money at their bank.

The Fed has always kept its target rate range in positive territory. But as part of its response to the financial crisis, it pushed its short-term rate effectively to near-zero levels at the end of 2008 and kept it there until December 2015, when it embarked on a slow campaign of increases. The federal-funds target rate range is now between 2.25% and 2.5%.

The Fed used additional stimulus during its near-zero rate period by way of multiple rounds of Treasury and mortgage bond buying aimed at lowering long-term rates. It also communicated in new ways to signal rates would stay low for a long time.

And while it never really found any constituency within the Fed, some outside economists said negative rates should be considered. With rates pushed into negative territory, cash accounts at banks would shrink in value. That would compel cash holders to take that money out and spend it, in turn providing stimulus to the economy.

Negative rates have made an appearance in other nations, but they faced considerable pushback in the U.S. and were never used. But the San Francisco Fed paper, which was written by Vasco Cúrdia, says that might have been the wrong call.

The paper says that a setting of negative 0.25% likely would have been the best setting to speed up the recovery without causing greater disruptions. It adds that inflation, which has yet to sustainably test the Fed's 2% target, may have even exceeded the Fed's official goal in 2011, which in turn would have allowed a much earlier start to the central bank's rate-rise campaign.

"Negative rates could have mitigated the depth of the recession and sped up the recovery, though they would have had little effect on economic activity beyond 2014," the researcher wrote.

The Fed may not be done with the negative rates debate. In today's low-rate environment, it is unlikely to raise rates as high as it did in the past. That means its rate target stands a good chance of falling back to near zero in the next downturn, thus once unconventional stimulus methods could make a return. Depending on how great the stress is, the Fed could weigh whether negative rates could help bring the economy back to health.

That said, monetary policy is made with trade-offs and unintended consequences in mind. For example, another paper published Monday argued that the central bank's ultralow rate policies may have given rise to monopoly-like concentration in the nation's business sector, which wasn't the aim of such policies.

While firms large and small all try to take advantage of low rates, the increase in activity "is always stronger for the leader," the paper said. "As a result, the gap between the leader and follower increases as interest rates decline, making an industry less competitive and more concentrated."

Greater domination or outright monopolies have lowered productivity rates and made the economy less dynamic, the paper by Ernest Liu and Atif Mian of Princeton University and Amir Sufi of the University of Chicago Booth School of Business, said. It may even feed into why wage gains have been so modest despite a solid job market.

Negative rates may help the economy, but they may cause unexpected problems, and policy makers will need to weigh that risk.

Write to Michael S. Derby at

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