The Federal Reserve, European Central Bank and other foreign monetary authorities are engaged in a dangerous race to the bottom — pushing interest rates to perilously low levels.
The Fed and ECB have targeted 2 percent inflation as a compromise for the trade off between inflation and unemployment, but that relationship is an inherently unstable and false compass for policy.
Since the financial crisis, U.S. inflation has fluctuated mostly below 2 percent whether the unemployment rate was 10 percent or less than 4 percent or the Fed pursued easy money or raised rates.
Since 2014, the ECB and other European central banks have gone negative — charging banks for deposits they must keep in their reserve accounts. That gives businesses access to ultra-cheap credit and national governments the odd privilege of charging investors for the privilege of holding their bonds — but negative rates have not broken the continental malaise and imposed more harm than good.
Economists have long known lowering interest rates has limited punch for boosting business investment and overall spending. In a crisis, ultra-low rates can provide more liquidity for businesses that will be fundamentally sound when the tumult passes; however, sustained for a decade, artificially cheap money has become an addictive drug.
Globally, many consumers, businesses and governments have simply borrowed too much and face catastrophe if the Fed normalizes rates to 3 percent or 4 percent — levels consistent with reasonable growth and inflation.
Ultra-low rates instigate asset bubbles in real estate markets, make the prudent management of pension funds nearly impossible and encourage zombie companies — terminally unprofitable enterprises that should be liquidated to release capital for more productive purposes.
Ultra-low rates weaken banks because when the rates they can charge on loans fall too close to zero, they can only lower interest rates paid depositors so much without a serf’s revolt. In Europe, only large businesses, not ordinary savers, are being docked negative interest on deposits.
In Europe, structural dysfunctions are to blame for lethargic growth. When the euro was established in 1999 assets, debts and prices were translated from the various national currencies at prevailing exchange rates. Since then, the productivity and competitiveness appear to have improved more in northern states like Germany and flagged in southern states like Italy.
That leaves the common currency undervalued for the North and overvalued for the South. Resulting trade deficits in the South require large government deficits to sustain demand and for Germany to spend more and reduce its budget surpluses.
Eurozone rules limit national deficits to 3 percent of GDP in the South, but Germany refuses to lead with fiscal stimulus.
The real benefit to Europe from negative interest rates is to push down the euro against the dollar, increase the overall trade surplus with the United States and essentially export some unemployment to America. That strategy has its limits as a frustrated ECB continues to forecast pathetic growth.
China and Japan similarly pursue cheap currencies against the dollar through easy money policies. And aided by multinationals’ ability to shift imports to third countries in response to U.S. tariffs, those have rewarded Mr. Trump’s trade war with a rising trade deficit and more job losses.
The 2017 tax cut raised consumer spending last year but has not delivered an increase in investment, and despite a $1 trillion deficit, the U.S. economy needs yet another fiscal jolt.
Mr. Trump can deride Federal Reserve Chairman Jerome Powell all he likes, but taking rates down, even perhaps to negative levels, won’t do much more to boost demand and growth. What is really needed is more fiscal stimulus — for example, an infrastructure program that would enhance long-term competitiveness and growth — but the Democrats and Republicans are unlikely to agree on a package before the 2020 elections.
The Treasury can fight fire with fire by selling dollars for euro, yen and yuan in foreign exchange markets through its exchange rate stabilization fund. This would require the Treasury to print bonds and exchange those for dollars at the Fed to obtain adequate ammunition — its Exchange Rate Stabilization Fund only has about $23 billion free to buy foreign currencies.
For the Fed, printing money for this purpose would have much greater positive impact on the U.S. economy than doing the same to further drive down interest rates, and it would discourage a futile and damaging international race to the bottom on interest rates.
• Peter Morici is an economist and business professor at the University of Maryland, and a national columnist.