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

How to Cook Spaghetti Squash (and Why)

Cooking for yourself is one of the surest ways to eat well. Bestselling author Mark Bittman teaches James Hamblin the recipe that everyone is Googling.

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

How to Cook Spaghetti Squash (and Why)

Cooking for yourself is one of the surest ways to eat well.

Video

Before Tinder, a Tree

Looking for your soulmate? Write a letter to the "Bridegroom's Oak" in Germany.

Video

The Health Benefits of Going Outside

People spend too much time indoors. One solution: ecotherapy.

Video

Where High Tech Meets the 1950s

Why did Green Bank, West Virginia, ban wireless signals? For science.

Video

Yes, Quidditch Is Real

How J.K. Rowling's magical sport spread from Hogwarts to college campuses

Video

Would You Live in a Treehouse?

A treehouse can be an ideal office space, vacation rental, and way of reconnecting with your youth.

More in Business

Just In