Tags: hatzius | negative | rates

Hatzius: Fed Rates to Negative Six Percent

By Michael Kling   |   Friday, 23 Jan 2009 03:51 PM

Even an interest rate of zero will be too high for a worsening economy, asserts Goldman Sachs Chief Economist Jan Hatzius.

The federal funds rate, now targeting zero percent, will have to be negative 6 percent by the end of next year to turn around the economy, he states in a research paper.

Unfortunately, it's impossible to have negative interest rates. But the Fed is not out of ammunition yet.

To achieve the effect of negative rates, the Fed needs inflation. For instance, inflation-adjusted, real interest rates are now below zero. But when inflation reaches a standstill this year, as many economists expect, even the real rates will return — upward — to zero.

The solution is to decrease real rates by increasing inflation, Hatzius argues. The Fed can do that by printing money and by pumping new reserves into the system by buying Treasuries and mortgage-backed securities.

Slashing interest rates is the Fed's main weapon for fighting recession. Lower rates make borrowing cheaper, encourage consumers to buy and businesses to invest, which then increases employment.

But even that won't bring back prosperity, Hatzius says. The Fed must also help banks clear bad assets from their balance sheets and the government must cut taxes and increase spending in a massive stimulus.

Stoking inflation could ward off deflation, which is a real danger, warn some economists. Japan suffered intractable deflation during its so-called lost decade of the 1990s.

Treasury Secretary nominee Timothy Geithner says bold government action is needed to stop the economic slide.

"If our policy response is tentative and incrementalist, if we do not demonstrate by our actions a clear and consistent commitment to do what is necessary to solve the problem, then we risk greater damage to living standards, to the economy's productive potential, and to the fabric of our financial system," he told Congress this week.

"In a crisis of this magnitude, the most prudent course is the most forceful course," Geithner said.

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Even an interest rate of zero will be too high for a worsening economy, asserts Goldman Sachs Chief Economist Jan Hatzius. The federal funds rate, now targeting zero percent, will have to be negative 6 percent by the end of next year to turn around the economy, he states in...
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