Martín Uribe - Universidad de Columbia.
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The document discusses the relationship between low interest rates and deflation, emphasizing that temporary low rates may facilitate reflation if accompanied by promises of future normalization. It examines cases in the United States and Japan, highlighting that low interest rates can lead to deflation if perceived as permanent. The Eurozone's situation is also explored, indicating the need for a shift from zero-interest policies to promote healthy inflation and economic growth.
Martín Uribe - Universidad de Columbia.
- 1. Do Low Interest Rates Help to Fend Off Deflation? Mart´ın Uribe Columbia University and NBER May 17, 2018 Navarra Center for Economic Development Roundtable
- 2. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Proposed Answer: • Yes, insofar as low interest rates are understood to be temporary. Specifically, if the monetary authority promises to begin normalizing interest rates as soon as the real economy is sound, even if the inflation rate is still below target. • If, by contrast, the public understand that interest rate will reamin low for an indefinite period of time, the economy may fall in a deflation trap. Two Examples • The United States • Japan An Open Question • Will the Eurozone follow the steps of the United States or Japan? 2
- 3. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? United States: Interest Rate 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 0 1 2 3 4 5 6 percent Federal Funds Rate United States: Inflation 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 0 0.5 1 1.5 2 2.5 3 3.5 Inflation, GDP deflator, yoy percentperyear Vertical lines: NBER recession dates, 2007Q4 and 2009Q2. Vertical doted line: end of liquidity trap, 2015Q4. 3
- 4. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Observations: • The United States were in a liquidity trap from 2008Q4 to 2015Q4. • While in the liquidity trap, the U.S. undershot its inflation target of 2%; inflation was 1.5 percent on average. • From 2011Q3 until exit in 2015Q4, inflation was not only below target but declining over time. • Once the policy rate was lifted inflation also started to rise. 4
- 5. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Japan: Interest Rate 1990 1995 2000 2005 2010 2015 0 1 2 3 4 5 6 Percentperyear Call rate Japan: Inflation 1990 1995 2000 2005 2010 2015 −3 −2 −1 0 1 2 3 percentperyear Inflation, GDP deflator, yoy Vertical lines: Cabinet office recession dates, 1991Q1, 1993Q4, 1997Q2, 1999Q1, 2000Q4, 2002Q1, 2008Q1, 2009Q1, 2012Q2, and 2012Q4. Horizontal line: inflation target. 5
- 6. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Observations: The nominal rate has been at zero for more than 20 years now. Inflation has never reached its target; in fact, deflation has been the norm. Japan has experienced a number of business cycles, all with rates stuck at zero. Thus deflation and rates at zero cannot be regarded as a cyclical phenomenon. Clearly, setting nominal rates at zero has not led to inflation going back to target. 6
- 7. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Eurozone: Interest Rate 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 −1 0 1 2 3 4 5 percentperyear Interest Rate, Eonia Eurozone: Inflation 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 −1 0 1 2 3 4 5 percentperyear Inflation rate, HICP, yoy Vertical lines: CEPR business cycles dates, 2008Q1, 2009Q2, 2011Q3, 2013Q1 7
- 8. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Observations: • Like the U.S., the euro area entered a liquidity trap in 2008. • Unlike the U.S., rates are still near zero (in fact -40 bp) as of May 2018. • Inflation has averaged 1.2% percent, which is below the inflation target of close to but below 2%. • Inflation has become more volatile. 8
- 9. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Interest Rates and Inflation in the Long Run The Fisher Effect i = r + π where i = interest rate r = real interest rate π = inflation If in the long-run r is determined by nonmonetary factors (technol- ogy, demographics, regulation, etc.), then this expression describes a one-to-ne relation between the interest rate and inflation. 9
- 10. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Average Inflation and Nominal Interest Rates in OECD Countries 0 2 4 6 8 10 12 14 16 18 0 2 4 6 8 10 12 14 16 18 inflation(%) t−billrate(%) OECD countries, longest consecutive observations (obs: 26) Note. 25 OECD countries. Each dot is one country. Average sample is 1989 to 2012. 10
- 11. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? What is the effect of an interest-rate shock on inflation? Theory suggests that the answer depends on (a) whether the change in the interest rate is expected to be transitory or permanent; and (b) the time horizon. Effect of an Increase in the Nominal Interest Rate Long Short Run Run Effect Effect Transitory shock 0 ↓ Permanent shock ↑ ↑ Entry (2,1): The Fisher effect. Entry (2,2) : The Neo-Fisher effect. 11
- 12. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? How Do Permanent Changes in the Interest Rate Affect the Economy in the Short Run? A VAR Model with • Temporary Interest-Rate Shocks • Permanent Interest-Rate Shocks. 12
- 13. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? Estimated Impulse Responses to Interest-Rate Shocks: United States 0 5 10 15 20 0 0.5 1 1.5 2 quarters after the shock deviationfrompre−shocklevel percentagepointsperyear Permanent Interest−Rate Shock Response of the Interest Rate and Inflation Interest Rate Inflation Inflation 95% band 0 5 10 15 20 −1 −0.5 0 0.5 1 quarters after the shock deviationfrompre−shocklevel percentagepointsperyear Temporary Interest−Rate Shock Response of the Interest Rate and Inflation Interest Rate Inflation Inflation 95% band 0 5 10 15 20 −0.5 0 0.5 1 1.5 quarters after the shock percentdeviationfrompre−shocklevel Permanent Interest−Rate Shock Response of Output Output 95% band 0 5 10 15 20 −2 −1.5 −1 −0.5 0 0.5 quarters after the shock percentdeviationfrompre−shocklevel Temporary Interest−Rate Shock Response of Output Output 95% band Source: Uribe, M. “The Neo-Fisher Effect in the United States and Japan,” NBER wp. . 23977, 2017. 13
- 14. Mart´ın Uribe Do Low Interest Rates Facilitate Reflation? What Does This Mean for Emerging Countries in the Eurozone? • In the period 2000 to 2008 nominal wages in the periphery of the eurozone grew on average 60%, in a context of low inflation ⇒ large increases in real wages. • Meanwhile, productivity was flat or decreasing ⇒ Demand driven real wage growth. • The GFC found the periphery of Europe with high wages and low productivity. • +Downward nominal wage rigidity (DNWR)⇒ widespread unem- ployment. • Nominal rigidity calls for a positive average rate of inflation for healthy adjustment of relative prices (e.g., real wages). • Positive average inflation requires abandoning the 0-interest-rate policy in favor of a gradual normalization of the type the U.S. Fed is implementing. 14