How does the Fed get out of this box?
They can't continue to jam rates negative in perpetuity without absolutely crushing the currency, which causes inflation, which means even more natural upward pressure on interest rates, which means even more forced Fed purchases of bonds, and more pressure on the currency - vicious positive feedback. There comes a point where rates have been held so low for so long that ever increasing Fed purchases are required to hold rates down, and the forces become self-reinforcing. There becomes no natural way to recover from the freefall into hyperinflation.
Once the Fed goes down the path of buying long-term debt, (or jamming short-term rates so far negative that they are directly financing negative rates on bonds; there's really very little difference in practice), it engages a cycle of positive feedback that can't be broken without substantial economic damage. Once the system is charged with too much free money at negative real rates, you can't let rates rise without a collapse in economic activity. And you can't continue to jam rates negative without a collapse in the currency and inflationary forces. It's a catch-22. Every day you hold interest rates negative, you are storing up negative economic charge to be released at a later date.
If you hold rates artificially high, you store up a little positive charge to release later, which is what the Fed is supposed to do when the business cycle is peaking. They can then release it when the cycle is troughing, or even go a little negative, storing up a little drag for when the economy is back in full swing and can afford it. But holding them below zero for too long is storing up an immense destructive charge.
Can somebody tell me, if you're the Fed, how you get out of this position *without* a depression or hyperinflation?
BC |
