Oh dear, what a pickle Fed President Janet Yellen has got herself into! Just a day after she announces her commitment to a 2015 rate hike, the September US Jobs report reveals a Labour market collapse across the board. If the Jobs data are re-conffirmed next month, then a rate hike is likely to be off the cards for many years. By locking herself into a typical Employment-based monetary policy rule, Yellen’s only alternative is to abandon the hiking agenda and start planning for negative interest rates in the same way that Japan and the ECB have done. And she will fail.
Is there an alternative way to run a monetary policy?
The famous ‘dot plot’ which summarises the interest rate recommendations of the Fed Governors and appears with the Fed’s rate decision, last month showed one Board member calling for negative interest rates. Narayana Kotcherlakota, the Minnesota Fed President, is widely believed to be this outlier. He is a Chicago trained economist so one would expect a Finance approach to policy. The popular press believes that Kotcherlakota has switched from hawk to dove while at the Fed, but this misinterprets his stance. His position is two-fold. First, since monetary policy is not capable of managing employment these rules should be abandoned. Second, since inflation by all current and future measures well below target, there is no reason to hold interest rates at any level above their minimum possible. Therefore, if the Fed can engineer negative interest rates, it should. Going forward, the Fed should tighten at its discretion only if inflation becomes a problem.
I like this approach since it targets a very low cash rate as the NEUTRAL. I had previously argued that the cash rate should float, but finding the true market level is complicated by the fact that the Central Bank is a major market participant without a proper competitive incentive. Kotcherlakota’s idea is for the monetary authorities to keep their guns firmly in the holster until they need them to fight inflation.
So while it looks like Kotcherlakota will get his negative interest rates, sadly they will be achieved in the name of ‘stimulus’, not policy advancement.