Thread by @J_MoAGoGo

Why negative interest rates won't cure stagnation:

There were claims this week that negative interest rates would work to boost employment and inflation. There were also some claims that Keynes' General Theory relied heavily on negative interest rates working. I take the opposite view on these points.

First of all, it's quite clear that the zero-lower-bound on nominal interest rates is more of a political rigidity than a functional one. But most economists in the New Consensus approach seem to think that breaking this rigidity would bring economies to full employment.

However, Keynes' General Theory develops arguments for why this wouldn't be the case.

In the General Theory, interest rates do not have a significant impact on spending/saving decisions, but rather affect portfolio choice. The issue with a deep stagnation when interest rates fall is that employment creating activities have little hope of positive return.

On the other hand, rent-seeking through the acquisition of non-reproducible assets such as land, commodities, patents, copyrights etc. will pay a positive return that is higher than the return on investment.

So even if interest rates go negative, loans will not be taken out to pursue investment while investment projects remain bleak, as there are other opportunities (that don't create employment) open to investors.

Orthodox economists, no matter how many Keymedian developments they claim to include, can't escape from the conclusion that stagnation is the result of monetary policy not working. But it's not the interest rate that's at fault, it's the return on investment.

In fact, while demand is depressed, firms will operate with spare capacity. Expecting investment to lead recovery via low interest rates is putting the cart before the horse. First output & cap utilisation have to expand. Otherwise investment will be insensitive 2 interest rates

There is also no guarantee that a negative interest on money will stop people hoarding money, in fact, it's not even likely.

In Keynesian portfolio choice models money carries a positive (diminishing) return from the liquidity services it provides. As a negative interest rate taxes away money (more on which later), this return will actually increase.

Not only this, but the chartalist perspective shows that money is necessary to settle tax liabilities. A reduction in money balances brought on by a negative interest rate could cause *more* people to cover it.

The strongest argument comes down to price & income effects. Usually I don't consider income effects of interest rates to be strong, as income from interest flows towards those with lowest marginal propensity to consume. But at negative rates, income effect is sure to dominate.

To legitimately break the ZLB barrier, you have to apply a negative interest rate to money. Everyone holds some of their wealth (such as that is) in the form of money, so a negative interest rate is essentially a tax on *everyone's* wealth.

This is certain to promote greater saving, as continued loss of money motivates greater hoarding, particularly as it is still necessary to settle nominal obligations, the most important being people's tax bills.

As an aside, the income effect of interest rates probably dominates in certain conditions prior to interest rates going negative.

Orthodox economists have recently grappled with the problem of the sign in the consumption Euler equation being the opposite of that implied by theory (I.e. interest rates are positively correlated with consumption)

When interest rates are low and stagnation sets in, those with the highest propensity to consume have no means of taking advantage of low interest rates, as credit is rationed and they have no assets.

Meanwhile lower interest rates mean that those with lower propensities to consume increase their savings to catch up with their retirement plans (which will be affected by low interest rates).

Because those with the highest MPC are shut out of taking advantage of low interest rates, the income effect dominates and the sign of the Euler equation changes.

This brings further trouble to the idea of the natural rate of interest, as the direction that interest rates work in depends on very specific conditions.