Tuesday, November 3, 2015

The Neutral Zone

As I write this, it is 9:32 AM on Sunday morning. Would have been 10:32, but we sprung back while I was sleeping. Scheduled for 4 AM Monday I have "Are we tight yet?" where I review an article about the Fed's problem in finding the neutral rate of interest. Therein I say:
If we define "the neutral rate" as the article does:

"the borrowing cost -- adjusted for inflation -- that keeps the economy at full employment with stable prices"

then I'm not even sure the neutral rate exists. Since the crisis, I mean.

At Marginal Revolution: What’s the natural rate of interest? Tyler Cowen writes:

Whether a given rate of interest both maintains full employment and stable inflation depends on the rate of productivity growth, for one thing. It can be that no single rate of interest can perform both functions.

Pretty much what I said.

I like the whole Marginal Revolution article. Lots of links that look most interesting. And a very good quote from Milton Friedman (of all people!).


The Arthurian said...

Brad DeLong is bemused by the way Tyler Cowen makes very heavy going of the simple concept of the natural rate of interest. ... Look, all we’re talking about is the rate of interest at which the economy would be more or less at full employment, which in turn implies that inflation will be more or less stable.

So Krugman still seems to think the neutral rate exists and we can get there. Of course it is Krugman who also says that the neutral rate is negative and we're stuck at the zero bound and this is a problem.

Meanwhile, central banks seem to be moving toward cash bans as a way to get around the zero bound. This is sick. Do you realize how sick it is? How bizarre?

Krugman and the rest of them have to stop moving forward with the analysis. They have to work backwards and unwind the mistakes of the past 30 or 40 years, and then move forward again, along a different path.

WHY have we reached the zero bound? Have they even considered this question? They keep saying we're AT the zero bound without considering HOW AND WHY we got there.

We got there because of EROC (Excessive Reliance On Credit). We got there because of the cost burden arising from private sector debt.

They'd rather take our cash than create policies that help us pay down our debt.

jim said...

Interest rates have fallen to the bottom because their are more dollars that people are trying to put in places where they can safely collect interest than there are dollars that people (who are credit-worthy) want to borrow and pay interest on. The same can be said for other currencies in Europe and Asia.

Paying down debt would result in even fewer places to put money that people want to collect interest on. That would drive interest rates even lower.

Before 2008 the US private sector was increasing its debts by $1 trillion every 3 months. When that stopped and went into reverse it created a huge shortage of places to put dollars to safely collect interest (the perception of what was "safe" also changed).
And at the same time the desire to save increased. That is to say, the desire to find safe places to park money and collect interest increased.