I Was Wrong About ZIRP

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Slim Pickens' finest cinematic moment i was wrong about zirp

Slim Pickens’ finest cinematic moment (click for larger image)

A few months ago, I argued that the Fed’s zero-interest-rate policy (ZIRP) would last forever.  Today I admit I was wrong about ZIRP.

[pullquote]Although negative rates have a “Dr. Strangelove” feel, pushing rates into negative territory works in many ways just like a regular decline in interest rates that we’re all used to, said Miles Kimball, an economics professor at the University of Michigan and an advocate of negative rates.[/pullquote]

Not, mind you, because the Fed will raise interest rates any time soon.  No, the geniuses at the Federal Open Market Committee and the Board of Governors seem to be leaning in a different direction: NIRP.

Better get used to seeing those initials.  They stand for negative-interest-rate policy.  That’s right.  The Fed thinks they can drive nominal short-term interest rates below zero.

For a good discussion of the Fed’s likely direction and its implications, see Greg Robb’s piece on Marketwatch.com. Greg gets it right here →→→→→→→→→→→→→→→→→→↑ [Update August 24, 2022: video has been deleted.  I have replaced it with the error message.]

We’ve Seen Negative Yields Before

Now it happens that there is a Treasury security that has paid negative interest rates off and on over the last couple of years: TIPS.  That’s Treasury inflation-protected securities.  These securities pay a real interest rate.  So when their yield is negative it simply means markets expect future inflation to be higher than current nominal interest rates.  (Remember the Fisher equation: r = i pe where r is the real rate of return on a security, i is the nominal return as usually quoted, and pe is expected future inflation over the life of the security.)

But negative nominal yields are a different kettle of fish.  Positive nominal yields mean borrowers are paying lenders to lend them money.  Negative nominal yields mean lenders are being asked to pay borrowers for the privilege of lending them money.  Most of the time that is insane.

Would NIRP Work? No.

And it would not make any difference.  The Fed has been flooding markets with liquidity for five years.  Virtually the entire tsunami has ended up being held as bank excess reserves at the Fed.  Why will more liquidity lead to a different result?  As I’ve argued in the past, monetary policy has done all it can to solve this crisisThings will not improve until (if?) a new president takes office and begins to undo some of the regulatory mayhem that the current administration has wreaked on the U.S. economy.

My guess is that the Fed thinks they can do this because there has been a global flight to safety.  And safety is still good old U.S. government Treasury securities.  Whether global markets want safety so much that they are willing to pay a premium to get it remains to be seen.  I, for one, am skeptical.  New Zealand, Australia, South Africa, Chile, the U.K., Norway, and Canada all have pretty safe government securities.  I predict the Fed will soon discover another result of globalization.


I learned a lot of what I write when I took monetary theory in graduate school. Prof. Karen Johnson (later my dissertation adviser), fresh out of M.I.T., inspired much of my thinking.  (I hardly have to add that Dr. Johnson is in no way responsible for my ramblings here.)  She understood both the theory (complete with heavy-duty math) and the practical aspects of monetary policy.  Sadly, I fear that institutional knowledge that I took for granted has been lost.

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.