In late August, I spent three days with central bankers from all over the world at the annual economic policy symposium sponsored by the Kansas City Federal Reserve Bank. This year’s main topic was how to improve future monetary policy. A major concern is about the ability of policymakers to respond effectively to a recession if the current low-interest environment continues. Central bankers have learned to lower interest rates to encourage borrowing in recessions and to raise rates when inflation threatens or occurs. Because interest rates are close to zero in all of the developed countries, some market participants fear that central banks will be powerless to act. Federal Reserve Chair Janet Yellen tried to reassure them at the meeting.
One possible answer might be to adopt substantially negative interest rates. Switzerland, Japan, and the European Central Bank have negative interest rates currently. A conference paper by my Carnegie Mellon colleague Marvin Goodfriend analyzed how negative interest rates can be made more effective. Yellen opposes the use of negative rates, but she may be forced to change her mind if a recession comes while market rates are low.
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