Keynesian case against negative interest rate

Off late negative interest rates have become a popular monetary instrument to stimulate economic growth in countries like Sweden, Switzerland, Denmark and even Japan. They do seem like an attractive option but not to Mr Robert Skidelsky, a professor of Political Economy at Warwick University. In his article, he mentions the Knut Wicksell’s theory that makes a distinction between market rate of interest (borrowing cost) and expected rate of profit. He attempts to explain that until now, we have a habit of looking at market rate of interest (negative ones) in isolation. So we immediately conclude that it will be successful in stimulating the market sentiment. But that’s our ceteris paribus fallacy, isn’t it? Because when the expected rate of profit is taken into account, only then can we gauge the impact of negative interest rates. He states that currently, expected rate of profit is itself negative so having negative market interest rates defeats the purpose. This is because it effectively means that the Central banks are foolishly trying to encourage enterprises to borrow when those enterprises are expecting negative returns (profits)!

The catch is, even if Central banks want to factor in this possibility of negative expected rate of profit, they cannot because it is an ‘expected’ and not an easily observable rate of return for the whole economy! This gives more info on Wicksell’s approach:

Apart from generic problems like depositors rushing to withdraw money from banks, he points out the folly of relying solely on monetary measures. That’s where Mr. Keynes comes into the picture: Government’s advocate! He quotes Keynes saying that negative interest rates could fail either when MPC is falling (more preference for liquidity) or when Wicksell’s expected rate of profit is falling faster than interest rates. Both these hurdles can be overcome by government expenditure. “The government would borrow the money directly from the central bank and use it to build houses, renew transport systems, invest in energy-saving technologies, and so forth.”

*The post was originally published on FISCUL facebook page of Lady Shri Ram College for women.


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