Has Monetary Policy Become Hazardous Groupthink?

Has Monetary Policy Become Hazardous Groupthink?

Global central banks recently have marched in lockstep toward ever “easier” monetary policy, with some now embracing negative interest rates. But nearly eight years after the global financial crisis, it is worth asking: Instead of stimulating growth and boosting inflation back to target, could extraordinary monetary policy actually be doing the exact opposite?

Today, global developed world monetary policy settings are more extreme than in the immediate aftermath of the crisis. What were once considered “emergency” policy settings have become the norm. These policies, coupled with massive amounts of open market intervention, have all aimed to lower nominal interest rates under the belief that lower rates are always good for growth and promote inflation. And yet, ZIRP, NIRP and QE have not yet delivered the results expected by the standard “new-Keynesian” models upon which they are based.

Perhaps the models that prescribe low (even negative) interest rates are simply wrong. After all, the theoretical underpinning of these models is not well grounded in empirical evidence. They seem to have worked much better in other eras when equilibrium interest rates were higher. To be fair, economies are far too complex to model with any certainty. And there is little historical precedent of extended periods of such extraordinary monetary policy. Yet, in light of the uncertainties, central banks continue to do more of what has clearly not worked based on models that have not been tested in the current setting. The almost religious fervor with which these polices are embraced seems to scale with their growing ineffectiveness rather than objective measures of success.

It may very well be that the economy and inflation don’t respond to interest rate cuts in a “normal” way when policy is so far away from normal. There may also be time and path dependencies that can alter effectiveness of a particular rate policy. Additionally, the feedback loops from expectations to outcomes are critical when thinking about monetary policy settings and are not well captured in conventional models. Importantly, there is growing empirical evidence that suggests extended periods of low, zero or even negative rates do not bring about the rebounds in growth and inflation that neo- Keynesian models predict. Look at the two decades of Japanese experimentation with low rates or the most recent examples throughout the rest of the developed world for most of the past decade.

Given these outcomes, some researchers and central bankers have begun to question the conventional modelling foundation for low and negative rates. (See James Bullard here and John Cochrane here.) This “neo-Fisherian” school of thought argues that pegging interest rates too low for too long can cause inflation to fall, ushering in a deflationary dynamic that can damage growth. What was once an appropriate and stimulative policy could morph into a counterproductive program that creates new and undesired equilibriums. Policymakers should take the time to question the efficacy of ever lower-for-longer interest rates rather than risk the possibility that groupthink monetary policy leads to a zombification of the economy.

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