Observations on Monetary Policy and the Zero Lower Bound

By Eric S. Rosengren

March 6, 2020

New York, NY

Current Monetary Policy: The Influence of Marvin Goodfriend

Shadow Open Market Committee and Manhattan Institute

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Six takeaways from Boston Fed President Eric Rosengren’s March 6 remarks at the conference “Current Monetary Policy: The Influence of Marvin Goodfriend”

Takeaway: Economist Marvin Goodfriend anticipated many policy challenges well before central banks were forced to confront them.

Excerpt: “Marvin showed a great deal of intellectual dexterity at a time when the United States was far from seeing short-term rates approach the zero bound. In many respects, [he] provided a prescient preview of many of the actions ultimately taken by global central banks during the Financial Crisis.”
Takeaway: Goodfriend suggested that negative interest rates might be an effective policy tool in some situations – but Rosengren remains skeptical, saying the experience in Europe and Japan shows the adverse side effects are likely quite large.

Excerpt: “In my view, negative interest rates poorly position an economy to recover from a downturn. … I view the recent experience of countries with negative rates as evidence that such a policy would not be particularly successful in stimulating economic activity. … [Also,] we need banks to be healthy enough to provide credit and liquidity in challenging economic times.”
Takeaway: Goodfriend foresaw that the equilibrium real rate of interest might fall to a very low level. This has significantly diminished the “space” for monetary policy to operate before hitting the effective lower bound.

Excerpt: “If the economic reaction to the coronavirus does result in the funds rate falling to its effective lower bound, [the observed] heightened sensitivity of the 10-year U.S. Treasury rate to adverse news raises the possibility that the 10-year U.S. Treasury rate could follow close behind. … As a result, there would be little room for the Federal Reserve to lower rates through large purchases of long-term Treasury securities – like it did to make conditions more accommodative in and after the Great Recession – if a recession occurred in this rate environment. Such a situation would raise challenges policymakers did not face even during the Great Recession.”
Takeaway: In a situation where both short-term interest rates and 10-year Treasury rates approach the zero lower bound, allowing the Federal Reserve to purchase a broader range of assets could be important.

Excerpt: “In such a case, as Marvin highlighted in his 1999 article, we should allow the central bank to purchase a broader range of securities or assets. Such a policy, however, would require a change in the Federal Reserve Act. … Alternatively, the Federal Reserve could consider a facility that could buy a broader set of assets, provided the Treasury agreed to provide indemnification.”
Takeaway: In a low-rate environment, an alternative to using monetary policy to stimulate the economy during a downturn is depending on fiscal policy to shoulder a greater share of the burden.

Excerpt: “Somewhat surprisingly, there seems to be little movement toward making [fiscal] automatic stabilizers more prominent, or preparing to invest significantly more in the sorts of public investment projects that yield positive returns."
Takeaway: Policymakers dealing with challenges should seek to emulate the boldness and imagination Marvin Goodfriend showed two decades ago.

Excerpt: “In 1999, Marvin Goodfriend was able to consider what had not occurred in the recent past, and contemplate bold alternatives. Over the next few years, that type of vision and boldness will be needed by all policymakers if we have to consider how policy should react to any large, adverse shock to the economy.”