Current concerns about the zero bound on interest rates
from Maria Alejandra Madi
Much of the comments on the global financial and economic crisis have focused on the proximate causes and governance issues related to risk management, monetary policy and weak regulation. New political alignments allowed a process of global financial deregulations in the early 1970s. The political ascendancy of financial capital and extensive capital market liberalization, employment goals were abandoned in the economic policy agenda. Indeed, price stabilization and “fiscal prudence” turned out to be the primary objectives of the economic policy. As a result, prior to the 2008 global crisis, inflation was low and close to official inflation target rates in the advanced economies. However, credit bubbles threaten the macroeconomic stability.
After the Global Crisis, academic economists and policy makers have actively participated in the debate on monetary policy in the United States and European Union. In the face of the outcomes of the crisis, central banks have dealt with a triple challenge
- how to contain the crisis
- how to prevent a recessionary downturn
- how to avoid enhancing financial instability in the form of inflationary pressures or asset and credit bubbles.
The Federal Reserve (Fed) and the European Central Bank (ECB) have faced major global financial challenges together. However, within their respective zones, they coped with their institutional set-up and governance guidelines.
After the bail-outs, their main concern is whether nominal interest rates really have a lower bound around zero per cent. After the crisis, central banks responded to the large fall in aggregate demand and the under- utilized productive resources by adjusting the policy interest rates to, or very close to, zero. Indeed, these central banks have focused on lender-of-last-resort program extensions. The main question is: to what extent central banks can deal with huge levels of leverage, structural flaws of financial innovations (securitization, structured finance, and derivatives above all) and lack of transparency in terms of risk management?. read more
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Edward Fullbrook and Jamie Morgan
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Real-World Economics Review Blog 
One thing that is very dissatisfying is that there are so many economists who completely abandon the idea of supply and demand and instead talk about interest rates as either something that “happens to us” or something that the Fed controls with an iron fist. It is true that our Fed has the abilty to put their finger on the scale by altering supply and demand, but they do so by working in the system, not by repealing the basic laws of nature.
When a single asset class heads toward the sky, then that might be considered a bubble in that asset class, but when all asset classes head toward the sky in unison, that is rather a bubble in the money supply that lies in the hands of investors compared with those that instead use their dollars to offer return on those investments.
The article says:
“The modern Keynesian literature emphasizes that, even if increasing the current money supply has no effect, monetary policy is far from ineffective at zero interest rates. What is important, however, is not the current money supply but managing expectations about the future nominal and real interest rates.”
Who knows? Maybe they are right to some degree, as the assumption that there is no “leakage” or “trickle down” of dollars pumped into bond markets to stimulate demand leads to the conclusion that we should have entered Great Depression II in the late 1980s. But is a permanent loss of a third to half our annual growth rate really the report card that economists want to bring home and brag about to the people of the US?
I would say we are reaching the limits of monetary policy. In the U.S. there was an opportune time after the election in 2009 to structurally remake the economy to put more emphasis on sectors for high productivity — not just in the manufacture of goods but in providing high-worth services — the high productivity of the U.S. is coming from smaller sectors of the overall economy than what the U.S. had in the 1960s when it had its highest levels of productivity in its history.
Similar to what went on after Sputnik, education could have gotten a lot more emphasis and there could have been a shift toward more highly productive sectors. This would also make fiscal policy more effective for stimulating demand within the industrial/commercial sectors. We are too much of a consumer economy (about 65% to 70%) and this makes the effectiveness of fiscal measures limited — during the ’60s the consumer sector was no more than 60%.