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| 5/23 |
| 2008/3/11-13 [Science/Electric, Finance/Investment] UID:49425 Activity:moderate |
3/11 Interest rate going below 0%? Is that silly or what?
http://www.msnbc.msn.com/id/23547244/page/2
\_ yeah its silly. Other stuff can happen that they dont mention
in that article, especially since the circumstances look distrubingly
like current environment. See, for example
in that article, especially since the circumstances look
distrubingly like current environment. See, for example
disturbingly like current environment. See, for example
http://en.wikipedia.org/wiki/Liquidity_trap |
| 5/23 |
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| www.msnbc.msn.com/id/23547244/page/2 My question is about the Federal Reserve lowering interest rates: I have heard that when the Federal Reserve lowers interest rates what they are really doing is creating dollars that didn't exist before in the attempt to create the interest rate they are targeting. So here comes my ridiculous question: If that is what they are doing, then why can't interest rates go below zero? Why is it impossible that they can create so much money that we have an interest rate of -1%? Your analysis of how the Fed targets rates is close: The "creation" of money comes from the Fed's actions in the bond market. The Fed's New York trading desk is the mechanism by which policy decisions are carried out through sales and repurchases of Treasury debt. If the Fed buys Treasuries, it takes cash from its own account and pays the holder of the bonds (usually big "money center" banks), who then send that cash circulating throughout the economy. To raise rates, the Fed sells Treasuries, mopping up excess cash and tightening credit. There are other tools in the Fed's arsenal, but these market actions are the most powerful and immediate. That's because inflation is burning a hole in the purchasing power of money while you're paying it back. Since you repay with inflated dollars, you're getting a break on the "real" cost of repayment. So If you borrow at 5 percent, and inflation is running 2 percent, you're really only paying 3 percent in real (inflation-adjusted) dollars. So you can see that if inflation is running at nearly 4 percent, and overnight interest rates are at 3 percent, we're actually in negative territory right now. If the headline rate actually went to 0 percent, and inflation rose, you can see how money would get cheaper much faster. The problem is that as inflation rises, money also loses its purchasing power much faster, which destroys savings and investment. Once that happens it's extremely difficult -- and painful -- to get inflation back under control, as former presidents Nixon, Ford and Carter learned. The real problem right now, however, is not the cost of money. So they're charging a lot more than they otherwise would. The reason they're scared is that no one knows just how bad or widespread the damage has been from the housing/mortgage meltdown. If you're Bank of America and Citibank calls up and asks for a loan, you may be wondering in the back of your mind if Citibank has come clean with all the bad news about its loan losses. Accounting rules give you some leeway in rolling over bad debts. If these bad debts eventually blow up, you don't want to be one of the parties on the list that is owed money. |
| en.wikipedia.org/wiki/Liquidity_trap When the relevant interest rate is already at or near zero, the monetary authority cannot lower it to stimulate the economy. The monetary authority can increase the overall quantity of money available to the economy, but traditional monetary policy tools do not inject new money directly into the economy. Milton Friedman suggested that a monetary authority can escape a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses. This is referred to as a money gift or as helicopter money (this latter phrase is meant to call forth the image of a central banker hovering in a helicopter, dropping suitcases full of money to individuals). Political considerations make it difficult for a monetary authority to grant the money gift, because individuals and firms not receiving free money will exert political pressure. The monetary authority must act covertly to give gift money to specific individuals or firms without appearing to give money away. Neoclassical Economics, believing economic agents care about real consumption rather than nominal consumption, (that is to say, they care about what they get in real goods, not how many dollars of goods they get) deny the existence of a liquidity trap. Agents do not care about nominal interest rates, but real interest rates. With this in mind, along with a skepticism concerning whether or not changes in the nominal interest rate have any historical evidence suggesting they significantly affect real goods produced, neoclassicists suggest the concept of a liquidity trap arises from a fundamental confusion about the difference between real consumption and nominal consumption, or the failure to recognize that real values are what economic agents derive decisions from. nominal interest rates cannot fall below zero, since no-one would voluntarily pay an interest to a borrower (ie, pay negative nominal interest rates). This sets a minimum limit on nominal interest rates, one that may be slightly above zero because of the liquidity advantages of holding money. The failure of these measures to help the economy recover, combined with an explosion in the Japanese public debt suggest that fiscal policy may not have been adequate either. |