What can monetary policy do? With unemployment rising and inflation well below target, this question should dominate next week’s meeting of the Bank of England’s monetary policy committee.
The Bank’s problem is that the two most obvious policy options don’t work. Yes, more quantitative easing (QE) would reduce gilt yields. But yields are already negative for shorter maturities. To paraphrase that noted economist Jay-Z, we got 99 problems but a high yield ain’t one. And the route from even lower yields to a stronger economy is not clear. In their new book Angrynomics, Mark Blyth and Eric Lonergan liken QE to filling up your kettle by sticking a hosepipe through your letterbox: it’ll work eventually, but inefficiently.
Nor would negative interest rates work. In effect, these tax banks for depositing money at the Bank of England. That might cut their profits and hence willingness to lend. And if banks pass on negative rates to savers, they are in effect imposing a wealth tax on us. And higher taxes do not stimulate economic activity.
In fact, negative rates might not even encourage borrowing. Some experiments by Mosi Rosenboim and colleagues at Ben-Gurion University have shown this. They found that cuts in interest rates from a positive rate to zero did indeed encourage laboratory subjects to borrow more to take on risk. But cuts from a zero rate to a negative one had no further effect. This could be because negative rates are so weird that they just confuse people. On top of this, there’s the danger described by Andrew Caplin and John Leahy in a classic paper in 1996. Negative rates would signal to everybody that the economy is in such trouble as to require unprecedented measures. That would be reason for us all to become more cautious – which means such rates would backfire.
The US Federal Reserve has rejected negative rates. There are good reasons why. None of this, however, means that monetary policy can do nothing. Blyth and Lonergan have two other ideas.
One is for dual interest rates. The Bank, they say, should lend to banks at a negative rate, conditional upon them relending this money at negative rates to companies investing in decarbonising the economy; this is essentially an extension of the Bank's term funding scheme. You might think it odd for the Bank to target a particular sector. But it isn’t. It has always supported the financial sector. Why shouldn’t it also support more socially useful ones?
And then there’s something more radical. Quite simply, they say, the Bank of England could just write us all a cheque: Mojmir Hampl and Tomas Havranek, two economists at the Czech National Bank, have proposed just this.
You might object that printing money would be inflationary. But that’s the point. Inflation would only rise as aggregate demand rises and unemployment falls. But these are precisely what we need. When we have below-target inflation as a result of weak demand, rising inflation would be a sign of policy success. And if inflation does rise too much, so what? The Bank has the tools and the knowhow to reduce it.
Of course, there remain questions about the relative merits of monetary and fiscal policy. The latter, for example, is much better at raising infrastructure spending and (if you care) reducing inequality. But the fact is that even at zero interest rates monetary policy can still do a lot. The constraint on policy is not a lack of tools but a lack of imagination.
