Home > Uncategorized > Whiplash effects of NIRP (Thomas Palley)

Whiplash effects of NIRP (Thomas Palley)

The potential future costs of financial fragility and asset price bubbles raise the prospect of policy whiplash effects due to contradictions between current and future policy actions.

The economy currently suffers from shortage of AD owing to systemic failings related to income inequality and trade deficit leakages. That demand shortage was papered over by a thirty-year credit bubble plus successive asset price bubbles, which eventually burst with the financial crisis of 2008. Now, central banks are seeking to revive AD via negative interest rates that will reflate the credit and asset price bubbles.

This policy is based on a contradiction. If it is successful, it will necessitate raising interest rates in future. That risks triggering another financial crisis as the new bubbles burst and the effects of accumulated financial fragility magnify the ensuing fallout. When asset prices are inflated, subsequent very small upward moves in the interest rate can produce large capital losses. In effect, policy measures to revive the economy now via NIRP can generate even greater imbalances that produce whiplash effects later.

This whiplash dynamic has been building over the past thirty years. Disinflation allowed successive lowering of interest rates from their double digit levels of 1980, thereby producing successively larger boom – bust cycles. That process appeared to be ended by the financial crisis of 2008 which pushed the economy to the ZLB. However, central banks are now seeking to circumvent the ZLB circuit-breaker via NIRP. If NIRP is pursued for an extended period of time, without remedying the deep causes of AD shortage, the prospect is a future more intractable economic crisis.

Why negative interest rate policy (NIRP) is ineffective and dangerous

  1. Grayce
    October 6, 2016 at 10:24 pm

    How does NIRP affect the “sweeps” practice of investment firms? That is, Wells Fargo moves money markets in and out of banks, and takes the overnight sweep. Likewise, when cashing in any holding they take the value from the client on one day, and either send a paper check (while the client gets nothing) or a few days later they issue a credit into the porfolio. Who pays the fee for the negative interest rate, and how would this change the practice?

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