Zero Bound

Last Tuesday, the Federal Reserve made the history-making but expected decision to lower interest rates (for banks borrowing money “short term”) to a range of “0% to 0.25%”. Theoretically, this will stimulate the economy, but no one actually seems to believe that allowing banks to borrow endless amounts of money for free will help very much.

Although the problem might lie more in the fact that a few economists control interest rates than what these economists do, we must nevertheless examine what they understand and how they view the world and the economy. Above all, one thing is clear – they view the economy as a machine, and they view interest rates as the primary lever by which to control it. Moreover, they believe it is their job to do just that: control the machine. All of their beliefs about what the economy is and what their role is are false. Since, however, there is no one to correct them, it is best to just acknowledge what they believe and move on.

One consequence of their beliefs, is that they have become addicted to the effects that raising and lowering interest rates have on the economy – but there is one tiny problem. What if they want the effects of lower interest rates when interest rates are already at 0%? If you understood the economy as a machine, and you only understood how to push or pull a lever to get the economy to balance out, what do you do when you’ve pulled the lever all the way down – but you want the effects of pulling it down further?

Fortunately, just this question was posed in 2004 by an up-and-coming economist. Unfortunately, this economist was Benjamin S. Bernanke. You may, if you wish, view the paper co-authored by Bernanke on this topic here, where to my knowledge he coins the term “Zero Lower Bound” which he uses to describe a (seemingly unfortunate) barrier to lowering interest rates. It is, in general, moderately interesting reading. Like most things that all of us write, it seems to be filled with some insights which are tightly coupled with an inability to see things we have not seen before.

The paper examines scenarios, and discusses the potential uses of artificially creating the effects of lower interest rates when a central bank is zero bound. It seems to consider lying to the public a valid strategy, but almost cautions against the completely unpredictable side effects of esoteric strategies – even while enthusiastic about their potential benefits. Ironically, Bernanke is now employing these experimental strategies on all of us.