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Fed Economist: V-Shaped Recovery Requires Negative Interest Rates

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Fed Economist: V-Shaped Recovery Requires Negative Interest Rates

Despite repeated statements from Federal Reserve Chairman Jerome Powell that the central bank would not consider negative interest rates in an effort to help our economy recover, at least one economist from the St. Louis Fed says that’s exactly what the country needs if we want a “v-shaped” recovery.

A paper was published Friday on the St. Louis Fed’s website. In it, Yi Wen, Assistant Vice President and Economist, argues that a “v-shaped” recovery is not only possible but necessary. The key to this is using “aggressive monetary policy” beyond what was used, Wen believes. He said we need to dig the country out of the financial crisis. This includes negative interest rates.

In his paper, Wen compared the government’s response to two major economic downturns: the Great Depression and the financial crisis.

He found that during the Great Depression, President Roosevelt’s aggressive fiscal response with the New Deal led to a v-shaped recovery. Meanwhile, the financial crisis saw an L-shaped recovery when the Fed only used monetary responses. These include the likes of low-interest rates and asset purchases.

“I found that a combination of aggressive fiscal and monetary policies is necessary for the U.S. to achieve a V-shaped recovery in the level of real GDP,” Wen wrote. “Aggressive policy means that the U.S. will need to consider negative interest rates and aggressive government spending, such as spending on infrastructure.”

S-Shaped Recovery

The combination of monetary and fiscal response should create an “s-shaped” recovery, according to Wen. There, growth starts slowly and then quickly bursts higher.

“Importantly, these policies also need to continue even when the crisis is about to end to provide a further boost,” he wrote. This leads “to a more robust recovery,” he also mentioned. “Furthermore, it’s the combination and coordination of both monetary and fiscal policies that provides enough stimulus for a V-shaped recovery. In other words, aggressive monetary policy — such as negative interest rates — may be ineffective on its own without aggressive fiscal stimulus.”

He warns that without both a monetary and fiscal response, “the economic consequences of the coronavirus pandemic will be permanent.”

But Chairman Powell seem to disagree. He and many of his colleagues have openly dismissed the idea of negative interest rates here in the U.S. They’ve expressed doubts that below-zero rates can become effective. In fact, he had a discussion last Friday with Alan Blinder, a former Fed Vice-Chair. During this conversation,  Powell said that they tend to become detrimental to banks.

“We don’t think that’s an appropriate tool here in the United States. I would say the evidence on whether it actually works is mixed,” Powell started. “Some negative side effects” still exist, “as there sometimes are with these things,” he also said. “it’s just not clear to my colleagues and to me on the Federal Open Market Committee that this is a tool that would be appropriate to deploy here in the United States.”

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