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View all search resultsMonetary policy beyond low inflation
A world wherein inflation is the least thing to worry about. In fact, they are struggling to push inflation up to avoid deflationary pressures on future welfare.
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n response to the COVID-19 pandemic, central banks around the world have been experimenting with unconventional policies. Normally, standard macroeconomic models prescribe substantial policy rate cuts during economic downturns to provide cushions to the economy. But central banks cannot always adhere to this prescription.
The United States Federal Reserves (Fed), for example, cut its policy rate by the average of 5.5 percent during recessions since 1957. But the Fed Funds Rate (FFR) was already at 1.75 percent in February 2020. So it had to be set at minus 3.75 percent to follow the historical patterns.
As setting negative rates is equal to taxing deposits, it can prompt fund owners to withdraw money from the banking system and to hoard cash instead. Hence, contrary to the normal nexus where a lower interest stimulates the economy, rate cuts below zero can discourage economic activities and introduce a deflationary spiral.
At this point, the Fed is arguably facing the zero lower bound (ZLB) on nominal interest rates. It prevents the central bank from lowering the FFR below the bound in response to adverse pressures to the economy. The ZLB is also known as the effective lower bound (ELB) since the bound can be nonzero.
In a way, Indonesia might be facing an ELB near the 4.5 percent if BI cannot make further cuts without causing capital to leave the financial system at large scales. Nevertheless, BI is living in a world where its peers are facing ELBs.
A world wherein inflation is the least thing to worry about. In fact, they are struggling to push inflation up to avoid deflationary pressures on future welfare.
Facing the ZLB, some major central banks dare to explore the negative-rate territory. The Fed, on the other hand, is visibly reluctant to experiment with negative rates. When the FFR hit zero in early March 2020, the Fed re-launched at full force the GFC-era assistance with additional variants. It prefers large-scale easing to negative rates by rolling out facilities known by their cryptic acronyms, e.g. CPFF, MMLF, PMCCF-SMCCF, and TSLF.
