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Negative Interest Rates vs. Higher Inflation

Summary:
On his blog, Ben Bernanke weighs the pros and cons of negative (nominal) interest rates vs. a higher inflation target to create monetary “policy space.” His main points are: Lower rates work immediately. In contrast, a higher inflation target only works once agents’ expectations adjust. A higher target may not be politically tenable a thus, not be credible. In contrast, “institutional changes … [such] as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates.” Both negative rates and higher inflation have negative side effects. But the side effects of negative rates would materialize only during bad recessions. There are reasons to expect that higher inflation would impose a relatively larger burden on the “poor” while negative interest rates would impose a relatively larger burden on the “rich.” The political risks for the Fed associated with a higher inflation target may be substantial.

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On his blog, Ben Bernanke weighs the pros and cons of negative (nominal) interest rates vs. a higher inflation target to create monetary “policy space.” His main points are:

  • Lower rates work immediately. In contrast, a higher inflation target only works once agents’ expectations adjust. A higher target may not be politically tenable a thus, not be credible. In contrast, “institutional changes … [such] as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates.”
  • Both negative rates and higher inflation have negative side effects. But the side effects of negative rates would materialize only during bad recessions.
  • There are reasons to expect that higher inflation would impose a relatively larger burden on the “poor” while negative interest rates would impose a relatively larger burden on the “rich.”
  • The political risks for the Fed associated with a higher inflation target may be substantial.
Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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