Could the US Federal Interest Rate be Negative?

[Frylock]

What formal or practical obstacles are there to setting the US federal interest rate at, say, -0.5%?

-FrL-

[Shagnasty]

Deflation is horrible and to be avoided at all costs. Basically, people make money by keeping their money and not spending it. That will stagnate the economy instantly. There was a thread on this one or two weeks ago.

[Mops]

Wouldn’t the main obstacle be that, faced with the choice of

1. lending the US government 100 , to get 99.5 back one year later
2. keeping the 100 , to have 100 one year later

everyone would choose the first alternative, i.e. there would be no takers for US treasuries?

[Captain_Carrot]

My Poli Sci professor said that it was possible for the Fed to lower the interest rate past 0%, and circumstances in which that would be the best option. Unfortunately, I don’t remember if he explained any more about it.

[Frylock]

@tschild

Wouldn’t the main obstacle be that, faced with the choice of

1. lending the US government 100 , to get 99.5 back one year later
2. keeping the 100 , to have 100 one year later

everyone would choose the first alternative, i.e. there would be no takers for US treasuries?

I would think a negative interest rate would mean

3. Borrowing $100 from the gov’t, and paying back $99.5 one year later

-FrL-

[ftg]

A few years ago, the overnight interbank loan rate in Japan went negative for a short while. This is one of the rates the Fed controls/watches here. I say it’s about time we showed those Japanese that Americans aren’t afraid of deflation and go negative!

[yabob]

@tschild

Wouldn’t the main obstacle be that, faced with the choice of

1. lending the US government 100 , to get 99.5 back one year later
2. keeping the 100 , to have 100 one year later

everyone would choose the first alternative, i.e. there would be no takers for US treasuries?

Or, for that matter, bank savings accounts with negative interest rates. If deflation was really rampant, so that you believed your dollar was going to buy more in the future, you might still do this for protection or insurance, rather than keeping your money under the mattress where somebody can break in and steal it. At that point, you are really paying a bank or the government to insure your money against loss.

[Freddy_the_Pig]

@Frylock

What formal or practical obstacles are there to setting the US federal interest rate at, say, -0.5%?

What do you mean by the “US federal interest rate”? Do you mean the T-bill rate at which the government borrows money? Do you mean the Fed funds rate, set by the Federal Reserve, at which banks are allowed to borrow reserves from each other? Do you mean the discount rate, at which the Fed itself loans money to banks? In the latter case, the problem is infinite demand–there is no reason for banks not to borrow an infinite amount of money if the interest rate is negative.

[Frylock]

@Freddy_the_Pig

Do you mean the discount rate, at which the Fed itself loans money to banks? In the latter case, the problem is infinite demand–there is no reason for banks not to borrow an infinite amount of money if the interest rate is negative.

Presumably there’s only so much money to go around?

Does the fed just loan out however much anyone asks for, whenever it asks?

-FrL-

[Freddy_the_Pig]

@Frylock

Does the fed just loan out however much anyone asks for, whenever it asks?

It normally loans only to member banks, but yes, generally as much as they want. The catch is that the interest rate is set so that they’ll only want a certain amount:

Primary credit is available to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee’s (FOMC) target rate for federal funds . . . The Federal Reserve expects that, given the above-market pricing of primary credit, institutions will use the Discount Window as a backup rather than a regular source of funding.

If the discount rate goes below market and negative, well, Katy bar the door.

So you may say, make the fed fund rate target negative as well. But the fed fund rate is only a target, for the rate at which member banks loan their reserves to each other. The Fed moves the fed fund rate toward the target by buying securities (usually T-bills) from member banks. Pump enough liquidity into the member banks, by buying enough securities, and the fed funds rate will fall. But it won’t fall below zero–a bank cannot profit, ever, by loaning to another bank at a negative interest rate.

[Frylock]

@Freddy_the_Pig

It normally loans only to member banks, but yes, generally as much as they want. The catch is that the interest rate is set so that they’ll only want a certain amount: If the discount rate goes below market and negative, well, Katy bar the door.

So you may say, make the fed fund rate target negative as well. But the fed fund rate is only a target, for the rate at which member banks loan their reserves to each other. The Fed moves the fed fund rate toward the target by buying securities (usually T-bills) from member banks. Pump enough liquidity into the member banks, by buying enough securities, and the fed funds rate will fall. But it won’t fall below zero–a bank cannot profit, ever, by loaning to another bank at a negative interest rate.

Yeah, I wasn’t expecting there to be profit in this. I was thinking of this as an extraordinary, non profit-oriented measure.

I also didn’t realize the fed loaned out however much the member banks asked for. If the rate went negative, clearly that would have to change as well.

-FrL-

[wmfellows]

@ftg

A few years ago, the overnight interbank loan rate in Japan went negative for a short while. This is one of the rates the Fed controls/watches here. I say it’s about time we showed those Japanese that Americans aren’t afraid of deflation and go negative!

You’re confusing real and nominal rates. Nominal rates in Japan were never less than 0, for the reason Tom mentined above, but effective real rates were negative.

[hawthorne]

Context: Liquidity Trap.