Negative Interest Rate Policy to Fight Secular Stagnation: Unfeasible, Ineffective, Irrelevant, or Inadequate?

ABSTRACT

This paper discusses three explanations for Secular Stagnation: Summers’s demand-side Secular Stagnation Theory, Palley’s Investment Saturation Hypothesis, and Gordon’s supply-side Secular Stagnation Theory. All three involve a judgement on the efficacy of a negative interest rate policy (NIRP) in tackling stagnation: according to the first it is unfeasible, according to the second it is ineffective (and even dangerous), and according to the third it is irrelevant. First, we argue that these theories face the fundamental difficulty constituted by the use of a (negative) natural (or equilibrium) rate of interest. We propose an original critique of the negative equilibrium rate of interest determined by the marginal efficiency of capital. Second, we claim that the negative interest rate policy is an inadequate tool to fight stagnation. While monitoring and fostering financial stability should be a fundamental role of monetary authorities, monetary policy is unable to stimulate growth, whereas fiscal policy is better suited to the task.

KEYWORDS:

• Secular stagnation
• monetary policy
• zero lower bound
• negative interest rate policy
• natural rate of interest

JEL CODES:

• E12
• E43
• E44
• E52
• E58

Acknowledgements

I am grateful to Antonella Stirati, Luca Salvatici, Giancarlo Bertocco and two anonymous referees for useful comments and critiques. Any errors are solely my own.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 Before Summers, Krugman (1998) on Japan and Bernanke (2005) on the ‘savings glut’ hypothesis also contributed to the New-Keynesian debate on stagnation.

2 In the course of the study I will not touch upon the issue of how to estimate the natural rate of interest (Laubach and Williams 2003; Holston, Laubach, and Williams 2017), and which controversies such an attempt is liable to generate (Levrero 2019; Taylor 2017).

3 For a more detailed reconstruction, see Seccareccia and Lavoie (2016, 201–204); Wieland (2018). Brancaccio and Fontana (2013) provide an alternative interpretation of this monetary policy rule.

4 It must be remembered that (unconventional) monetary policy is not limited to NIRP. There are other measures, such as forward guidance (McKay, Nakamura, and Steinsson 2016) or quantitative easing (Palley 2015), which have come into play in recent years. Reviewing these is outside this paper’s scope.

5 Obviously, there is no such thing as a single monetary policy conduct shared by all central banks. For an example of the concrete differences between one single-country central bank strategy and that of others, see Lavoie (2019) on the Canadian case.

6 Other central banks that have implemented it are those of Denmark, Switzerland, Sweden and Japan.

7 The ‘corridor’ is constituted of three interest rates which are policy-set: the deposit facility (DF) rate, charged on banks making overnight deposits with the Eurosystem (the floor); the main refinancing operations (MRO) rate, charged on banks borrowing liquidity from the Eurosystem against collateral on a weekly basis; the marginal lending (ML) rate, charged on banks receiving overnight credit from the Eurosystem (the ceiling). Within the corridor we can see two other interest rates: EONIA (Euro Over Night Index Average), that is, the one-day interbank interest rate for the Euro zone, and EURIBOR (Euro Interbank Offered Rate), that is, the average interest rate at which European banks borrow from each other (the values in the series refer to a three-month horizon). For ECB monetary policy decisions see https://www.ecb.europa.eu/press/govcdec/mopo/html/index.en.html and also ECB (2011, Ch. 4).

8 Homburg (2014), within a neoclassical framework, claims that advanced economies cannot be supposed to feature a negative natural rate of interest because of the presence of a non-reproduced asset, which he identifies as land.

9 Palley’s representation is more complex. Indeed, in his papers there are three demand curves (real capital, money, NRAs) and two supply curves (loans, equities). Moreover, he first describes a ‘normal’ situation with a positive rate of interest and then the ‘stagnation’ situation with a negative interest rate. I simplify the treatment by looking only at the stagnation case, deploying one supply curve of loans and two demand curves (real capital and NRAs). The overall demand curve is placed at the outer envelope of these two. These simplifications do not alter Palley’s scheme.

10 In this case, referring to equations (1) and (2) is not entirely appropriate, as Palley moves outside that paradigm. We retain the notation for the sake of simplifying the presentation.

11 Even though nowadays it has gone out of fashion, this approach allows us to gain a straightforward picture of the issue. Obviously, in the literature other formalisations for investment modelling can also be found, such as Tobin’s Q, Jorgensonian approaches, and so forth; see Petri (2004, Ch. 7).

12 However, it must be remembered that the two schedules in Palley’s model are not strictly analogous to the conventional ones used by Summers.

13 In the figure there are three possible intersections between the two curves. For an example in which the theory is unable to pick which rate of interest will be selected as the equilibrium point, see Fratini (2007).

14 For other contributions that start from different inspirations but also advocate the necessity to study and address stagnation without resorting to a natural rate of interest and focusing on aggregate demand, see Bertocco and Kalajzić (2019a, 2020), Hein (2016a, 2016b), Skott (2016).