Watch Live: The Washington Ideas Forum 2014

Central Banking Needs New Rules

Things we thought we knew about central banking are no longer so clear.

[T]he past three years have shown that central banking can't be above politics -- not, at any rate, for the reasons previously given. Whether aiming for stable prices makes sense is actually a complicated question. And the line that separates supposedly technical issues of monetary policy from the unavoidably political issues of taxes and public spending turns out be fuzzy.

Why is the case for low inflation in doubt? Because the most powerful remedy for recession is lower interest rates. The deeper the recession, the more aggressive the cut in interest rates needs to be. A "stable prices" mandate for the central bank means that interest rates will be low to begin with, and however deeply the central bank might wish to cut them, it cannot cut them to less than zero.

In typical recessions this problem of the "zero lower bound" doesn't arise, because a moderate cut in interest rates is all that's needed. But the recession that started in 2008 was ferocious. The Fed cut interest rates to nothing, and it wasn't nearly enough. On some estimates, it should have cut rates by five or six more percentage points -- but a nominal interest rate of minus 5 percent isn't possible.

Not unless you abolish physical money--which is what prevents negative nominal interest rates. It's a seemingly outlandish idea which needs to be taken more seriously. (See this paper on the zero lower bound by Willem Buiter.) And if not that, then what? I discuss the options in Great Recession Demands New Rules for Central Banks.

Presented by

Things Not to Say to a Pregnant Woman

You don't have to tell her how big she is. You don't need to touch her belly.

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

blog comments powered by Disqus

Video

Maine's Underground Street Art

"Graffiti is the farthest thing from anarchy."

Video

The Joy of Running in a Beautiful Place

A love letter to California's Marin Headlands

Video

'I Didn't Even Know What I Was Going Through'

A 17-year-old describes his struggles with depression.

Video

Google Street View, Transformed Into a Tiny Planet

A 360-degree tour of our world, made entirely from Google's panoramas

Video

The Farmer Who Won't Quit

A filmmaker returns to his hometown to profile the patriarch of a family farm

Video

Riding Unicycles in a Cave

"If you fall down and break your leg, there's no way out."

Video

Carrot: A Pitch-Perfect Satire of Tech

"It's not just a vegetable. It's what a vegetable should be."

More in Business

Just In