Rogoff on the Zero Lower Bound

I was at the ASSAs in Chicago this past weekend. [1] One of the most interesting panels I went to was this one, on Advances in Open Economy Macroeconomics. Among other big names, Ken Rogoff was there, as the discussant for a rather strange paper by Pierre-Olivier Gourinchas and Helene Rey.

The Gourinchas and Rey paper, like much of mainstream macro these days, made a big deal of how different everything is at the zero lower bound. Rogoff wasn’t having it. Here’s a rough transcript of what he said:

The obsession with the zero lower bound is encouraging all kinds of wacko ideas. People are saying that at the ZLB, productivity increases are bad (Eggertsson/Krugman/Summers), protectionism is good (Eichngreen), price flexibility is bad, and so on.

But there is an emerging literature that says economists are taking the zero lower bound too literally. In fact, getting negative rates is not that hard. So before you take seriously these, let’s say, very creative ideas, it would be simpler to think about getting rid of the zero bound.

There are lots of ways to do it. I talk about some in my book, but people already understood this back in the 1930s. There was Robert Eisler’s proposal to have banks accept cash deposits at a discount, for instance, which would have effectively created negative rates. If Keynes had read Eisler, he might have gone in a different direction. [2] It’s a very old idea — Kublai Khan did something similar. There will be pushback from the financial sector, of course, who think negative rates will be costly for them, but fundamentally it is not hard to do.

These rather striking comments crystallized something in my mind. What is the big deal about the ZLB? For mainstream macroeconomists, including Gourinchas and Rey in this paper, the reason the ZLB matters is that it prevents the central bank form setting an interest rate low enough to keep output at potential. [3] It’s precisely this that makes inapplicable the conventional analysis of a nonmonetary problem of allocating scarce resources between alternative ends, and requires thinking about other entry points. If the central bank can’t solve the problem of aggregate demand then you have to take it seriously, with all the wacko and/or creative stuff that follows.

In the dominant paradigm, this is a specific technical problem of getting interest rates below zero. Solve that, and we are back in the comfortable Walrasian world. But for those of us on the heterodox side, it is never the case that the central bank can reliably keep output at potential — maybe because market interest rates don’t respond to the policy rate, or because output doesn’t respond to interest rates, or because the central bank is pursuing other objectives, or because there is no well-defined level of “potential” to begin with. (Or, in reality, all four.) So what people like Gourinchas and Rey, or Paul Krugman, present as a special, temporary state of the economy, we see as the general case.

One way of looking at this is that the ZLB is a device to allow economists like Krugman and Gourinchas and Rey — who whatever their scholarly training, are aware of the concrete reality around them — to make Keynesian arguments without forfeiting their academic respectability. You can understand why someone like Rogoff sees that as cheating. We’ve spent decades teaching that the fundamental constraint on the economy is the real endowment of resources and technology; that saving boosts growth; that trade is always win-win; that money and finance matter only in the short run (and the short run is tolerably short). The practical problem of negative policy rates doesn’t let you forget all of that.

Which, if you turn it around, perhaps reflects well on the ZLB crowd. Maybe they want to forget all that? Maybe, you could say, they take the zero lower bound seriously because they don’t take it literally. That is, they treat it as a hard constraint precisely because they are aware that it is only a stand-in for a deeper reality.


[1] The big annual economics conference. It stands for Allied Social Sciences Association — the disciplinary imperialism is right there in the name.

[2] This was an odd thing for Rogoff to say, since of course while Keynes didn’t discuss Eisler as far as I know, he talks at length about the similar proposals for depreciating cash of Silvio Gesell and Major Douglas. Notoriously he says these “brave cranks and heretics” have more to offer than Marx.

[3] Gourinchas and Rey are reality-based enough to say “the policy rate,” not “the interest rate.”


EDIT: Added the seriously-but-not-literally phrasing as suggested by Steve Roth on Twitter.

15 thoughts on “Rogoff on the Zero Lower Bound”

  1. The barrier to recovery thru monetary instruments
    In a recession is not the lower bound it’s the liquidity trap

    We have this awful mono causal function that investment however defined is driven by interest rates

    Nd there is always. Rate low enough even if this means a real total payback
    lower then the initial real loan

    What if credit is about default risk
    Not real cost

    We need to dump 30’s hicks entirely

    Look at models of the credit system
    along the Stigilitz lines

    1. That’s right. Among other things, the fact that you’re hitting the ZLB is a result of the fact that you’re making big moves in the policy rate, which is a sign that output is not very responsive to it.

      I was actually looking for a good link for output being insensitive to interest rates, but couldn’t quickly find one. But of course it used to be common wisdom “can’t push on a string,” etc.

  2. The beauty of the liquidity trap is perhaps tacit recognition the economy can break out of a mono tonic functional relation between real interest rates and spending

    The existence of
    A Variable “state of the economy”
    “macro Default risk ”
    combined with a credit system
    Run by for profit privateer lenders

    Spells stagnation

  3. We need a state based credit system like people’s china
    Where credit flows can defy
    the default cycle
    Increasing net loans even as actual delinquency and default rises
    and expectations worsen

  4. “have banks accept cash deposits at a discount, for instance, which would have effectively created negative rates.”

    This, in my opinion, is bunk.
    The idea is that the interest rate should be low enough to entice people to borrow and invest in the real economy, so the banks should not borrow (take in deposits) at negative rates, but LEND at a negative rate (lending money to some guy and then paying him to keep the money).
    It is quite obvious that banks will not do this, probably cannot do this, and even if they did people would borrow and then not invest.

    In my view the capitalist economy as we know it doesn’t tend to an happy full employment high wages equilibrium, but instead to a nasty low employment, low wage, underconsumption equilibrium.
    For a while (in the postwar years) governments counteracted this tendency through stimulus and redistributive policies, then government dropped these redistributive policies and substituted lowering the interest rate to stimulus (as lowering the interest rate causes an increase on total debt, that increases consumption). But as governments had to lower the rate more often than they could raise it, we reached the ZLB.

    All the misterious bad policies that turn good once in the ZLB are just policies that raise the wage share on income (e.g. increases in productivity are “bad” because wages don’t keep pace with productivity, so the real problem is wages, not productivity).

    1. More generally negative interest rates are the financial counterpart of a negative rate of profit, but no one would invest for negative profits; hence the ZLB.
      The “negative” rate of profits come because there is some limit to purposeful investiment but, as demand for consumption goods is limited by the low wage share, investiment demand is needed to keep the ball running.
      So IMHO the problem is that we are already close to “potential”, but wages don’t rise enough to take the place of the “investiment” component of aggregate demand.

      1. Now here I don’t agree. I think it’s a mistake to see interest rates, which are a specifically financial phenomenon, as corresponding in any direct way to the general rate of profit. Certainly measured profit rates today are quite high.

        1. (Sorry for the really late answer, I had to think a lot to come out with a coherent explanation of my opinion)

          “Certainly measured profit rates today are quite high.”

          What have the high rate of ptofit to do with the fact that there are still avenues for new real (nonfinancial) investiment?

          In my opinion the underlying idea is that, as companies build new factories and hire more workers, either competition increases or worker’s wage increase (actually these are two way to state the same thing), thus cutting the profit share of income.
          But if we think in these terms, then we should assume that when the economy runs at maximum, the share of profit should be zero or close to zero, which is quite unlikely for a capitalist economy.
          Therefore, there has to be a point when a capitalist economy stops to invest, before reaching the absolute maximum level of output.

          The total amount of profits is total incope multiplied by the share of profits; when the economy expands, new factories are created, and unemployment falls, total income increases proportionally but the share of profits falls, thus there is a point when additional capital goods, while still increase total income, will decrease total profits.
          At this point, from the point of view of aggregate capital, an additional amount of capital has a negarive marginal rate of profit, even if it still has a positive effect on total income.

          In my opinion, when “the economy” reaches this point or is near to this point, it reaches the “peak” employment cycle, and is what we generally mean by “potential”, even though it isn’t the actual theorical potential (that would imply 0 profits).

          When the economy reaches “peak”, how high will the share of profit be? It depends on the shape of the curve of wages. Wages however depend on many factors so the shape of the wage curve may change a lot, so it is possible that when the economy reaches the “peak”, wages are still quite low and profits quite high (but an ulterior expansion would still lower aggregate profits).

          In this situation, IMO, the economy finds itself in a situation of chronic underconsumption, where “excess profits” can be turned into consumption only as consumption loans or indirectly through financial speculation, that more or less works as an indirect consumption loan.

          This is in my opinion the situation in which we are now, and in this situation an high rate of profit doesn’t in itself mean that there is still “space” for new remunerative investiments from the point of view of capitalists, even though there is still space for productive investiments from the point of view of society at large.

    2. I think this is basically right. But I also wouldn’t exclude other factors besides low wages that tend to depress demand — slower population growth, fewer major innovations, less competitive markets, more intangible capital.

  5. I am as lefty and radical as the next guy (I supported Sanders), but still chafe at the notion about monetary policy “pushing on a string” or being infeffective.

    I agree it becomes less effective, and one has to do more, but if I were in charge, I could get inflation to rise. The Fed or BoJ just refuse to do enough. They’re too conservative. Unlike Rogoff or the Market Monetarists, I prefer fiscal spending and would endorse the state-credit system Paine suggests, however I tend to agree with Yellen who says unconventional policy can handle downturns.

    The last recovery was horrible but we have to remember that the Republicans forced unprecedented austerity on the economy with the sequester etc as Obama went in for compromise over deficit reduction.

    Yellen has said the Fed can handle downturns but DeLong also has quote a 2009 quote her where she explains why the Obama stimulus was helpful (per Krugman, Gourinchas and Rey and the ZLBers.)

    “I am sanguine that the Fed’s new programs will be helpful in restoring credit flows. But many of the new approaches are experimental, and there is a great deal of uncertainty concerning their likely effects. Even with vigorous Fed action to restore credit flows, an extended period of economic weakness is likely. This explains why, in the statement following its December meeting, the FOMC noted that it anticipates that an exceptionally low level of the federal funds rate will be appropriate for some time.

    For all of these reasons, I support Marty [Feldstein]’s conclusion that there is an exceptionally strong case for substantial fiscal stimulus over the next few years. In ordinary circumstances, there are good reasons why monetary, rather than fiscal policy, should be used for stabilization purposes. But these are exceptional circumstances, and fiscal policy can help get the economy going…”

    1. Well, it’s some mix of don’t want to hit target, can’t hit target with conventional tools, can’t hit target at all, and there isn’t any target. In this context the exact mix doesn’t matter so much. The important thing is that you can’t assume that thanks to central bank output always gravitates to potential.

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