Everyone, Act Natural!…and the Economy Will Too?

PIMCO (Pacific Investment Management Company) has a history of being a thought-leader in the financial industry, but their recently released insight–here–on the effects of central banks instituting negative interest rate policy (NIRP) is laughable.  Granted, NIRP is largely untested and, given its potential to harm bank profits and investor/consumer attitude (among other things), is by no-means a panacea or even a sure-fire net positive.  Indeed, the U.S. Federal Reserve has not yet firmly suggested NIRP as a policy tool should the Fed need it, but given that other major central banks are trying it (most notably the European Central Bank and the Bank of Japan) and the Fed is increasing its research on NIRP, PIMCO is nervous and wants interest rates to go the other way.

Most of the points made in the PIMCO piece are so off-base that they’re not even worth addressing individually.  But the general attitude of the whole insight–that “normalizing” interest rates (a crude way of saying, “aligning interest rates more closely with historical averages”) will make everyone feel better and thus boost inflation/inflation expectations to the Federal Reserve’s target–is so far off base that it’s in a different stadium.  Since the financial crisis, every major central bank that has attempted to raise rates to return to a “normal” level of interest rates has ended up reversing course (with the exception of the U.S. Fed…so far—though, the Fed reversing course is not my base case).  The U.S. is the only major central bank that currently has an upward trending policy; it raised its target rate at the end of last year by 0.25%.  So, according to PIMCO, we should be seeing an increase in inflation expectations.  Wait…


The other point they make that I’ll address is one that gets thrown around all too often and all too lightly: this is about winning the currency war.  The argument goes: lower interest rates will lower the value of the dollar relative to other currencies so our exports will become relatively cheaper and global demand for them will increase; other central banks will respond by doing the same; then, our only response will be to cut interest rates further to again retain that trade advantage, and the cycle will continue.  This argument, of course, falls apart when you consider the positive demand shocks for all goods–including imports from other countries–that lower interest rates create.  Further, and perhaps more importantly at present, given the U.S. dollar’s wide use all over the world in pricing trade, denominating loans, denominating corporate and sovereign debt issuances, and serving as the basis for many emerging market currency pegs, the dollar’s appreciation relative to other currencies is roiling global asset markets and increasing volatility much more than negative interest rate policies among a few central banks.  A depreciated dollar wouldn’t be the start of a currency war; it would be a boon to financial world peace.



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