Reader Tim stated “I really don’t see why negative rates could not occur naturally especially in a deflationary environment“.
In my article I stated upfront “Anyone with an ounce of common sense knows that negative interest rates cannot occur naturally, can only occur with government or central bank intervention, have nothing to do with free markets, and must fail eventually.”
In light of Tim’s question, let’s explore that idea.
According to the textbooks, this so-called natural rate is the inflation-adjusted rate that’s consistent with the economy operating at its full potential, expanding without overheating. Also known as the equilibrium or neutral rate, it balances savings and investment.
The natural rate can’t be observed directly; the Fed knows it has been reached only by how the economy responds. “It’s like discovering Pluto: you can only see the effect of the gravitational pull,” said Eddy Elfenbein, an investor and blogger at the site Crossing Wall Street, comparing it to the dwarf planet whose existence was inferred from the orbits of Uranus and Neptune.
“We’re seeing no pickup, none whatsoever, in the natural rate even as the economy has gotten back to full strength,” John Williams, the San Francisco Fed president who has spent years studying it, said in a recent interview with The Wall Street Journal.
“I think the current level of neutral or normal rates is pretty low,” Fed Chairwoman Janet Yellen said in Philadelphia last week. She expects it will rise over time, but said “that is something we’re uncertain about and have to find out over time.”
Fed Vice Chairman Stanley Fischer this year predicted the natural rate will remain low for the next few years, and warned that factors governing the rate are “extremely difficult” to forecast.
“The answer to the question, ‘Will [the natural rate] remain at today’s low levels permanently?’ is that we do not know,” he said in a January speech. “Eventually, history will give the answer.”
Fed Nods to Negative Rates, Hurdles and All
Federal Reserve Chairwoman Janet Yellen waded into fraught territory before Congress, suggesting the central bank could turn to negative interest rates in an economic downturn despite legal and other uncertainties.
When questioned about the possibility, however, she said it could be done if necessary.
“I’m not aware of anything that would prevent us from doing it,” Ms. Yellen said.
No Laws Prevent Stupidity
While nothing legally might prevent negative rates, please note that there are no laws that prevent stupidity.
With that thought, let’s return to Tim’s question.
Negative Rates Logically Impossible
Negative rates are logically impossible because they imply a negative time preference. That statement may be over the heads of most, so let me phrase it a different way.
“Negative interest rates imply that one would rather have 90 cents tomorrow than a dollar today!”
Phrased that way, negative interest rates are logical idiocy. I am not trying to be harsh on readers like Tim. Indeed, I am thankful he brought the question up.
It’s easy for many readers to fall into the trap of listening to mainstream media.
However, Janet Yellen (or any economist) is either a clueless idiot or a big liar or both, to ever state or imply that time preferences can ever be negative or even zero.
Yet, this is what we are dealing with.
In regards to the “natural rate“, economists note that it can only be observed, not set. I agree. Yet central planner fools at the Fed (central banks in general), all think they can set the natural rate.
The Bank of Japan and the ECB illogically set the rate negative, with detrimental consequences.
The Fed sponsored asset bubbles in 2000, 2007, and again now in search of the “natural rate”.
This is all so obvious, it’s beyond belief. And it has been going on for years. Yet, every Humphrey Hawkins meeting (when the Fed Chair addresses Congress and Congress gets to ask the Chair questions), the Congressional questions and comments have been beyond lame.
I would have crucified Bernanke and would do the same with Yellen. It’s a trivial matter to do so actually.
Time and time again, Congressman Ron Paul launched into worthless tirades instead of asking a series of pointed questions that would have trapped Bernanke no matter how Bernanke responded.
Paul fans cheered. But with every one of his wasted tirades, I nearly thew up at the lost opportunities.
Here’s the bottom line on Paul: He preferred hearing himself talk than asking a series of questions sure to make Bernanke look like an idiot.
In the doubtful chance that any Congressman or Senator is interested in hitting Janet Yellen hard with a series of no-win questions for her as opposed to wasting time in meaningless rants, please get in touch.
Mike “Mish” Shedlock