MNI INTERVIEW: Negative Rates Worsen Liquidity Traps: Fed Econ

By Evan Ryser

     WASHINGTON (MNI) - Negative interest rates worsen U.S. downturns where

pessimism about the prospect of falling prices reign in a liquidity trap, Kansas

City Fed economist Andrew Glover told MNI.

     The Fed might have to drive interest rates much farther below zero than

anything deployed by the ECB or BOJ to pull the economy out of a weak patch

where consumers and companies believe prices are in a downward spiral, Glover

said in an interview before the Fed's blackout period. The levels required are

"logically impossible" and approach -100% according to his research.

     "If you're in a situation where you can't manage expectations then trying

to do it with this nominal interest rate going a little bit negative, it's

unlikely to be enough," Glover said. "You need other tools that more directly

affect inflation expectations."

     In the middle of a year-long Fed review of policy tools and pressure from

President Donald Trump to slash borrowing costs, officials have signaled

negative rates have some power to curb future recessions. Minutes of the Fed's

October meeting said "participants did not rule out the possibility that

circumstances could arise in which it might be appropriate to reassess" negative

rates.

     That situation could arise next year according to the New York Fed's Survey

of Primary Dealers from October showing a 10% probability of the federal funds

rate falling below 0% at the end of 2020. The New York Fed's Survey of Market

Participants at the 25th percentile also saw the effective lower bound at

-0.38%.

     Glover said the effective lower bound is "certainly" slightly negative now

given the actions of central banks around the world, while other Fed economists

have been slightly agnostic.

     He also made clear the impact of negative rates is contingent on how the

economy ends up at the lower bound and stressed they can bring an improvement.

     One scenario is where companies are hoarding cash, and the policy can make

it more profitable to spend on new equipment instead. "Negative interest rates

can undo the reduction in investment by leading firms to pull resources out of

bank deposits and into physical investment," Glover said.

     "The effects of negative interest rates depend on why we feel the need to

use them. Why did we get to zero and how far negative can we go?" Glover said.

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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