ECON141: When cash rates go negative

Last time I discussed how the cash rate influenced the interest rate.  But what happens when the cash rate goes negative?  This is the focus of today’s post.

After recent discussions about “negative interest rates” across Australasia I thought it would be useful to talk about how these rates appear mechanically at a high level (in terms of financial system operations).

In class (and Gulnara’s posts here) the motivation of why negative interest rates might be appropriate in a policy sense was raised.  Furthermore, she did a great job of noting that it is unlikely that negative rates will cause additional savings (as some have claimed) and so theoretically we can continue to think about our investment model with negative interest rates.

For this post we will assume that the central bank is trying to influence interest rates towards a level that will “close the output gap” or “push Y to its sustainable level” and achieve their inflation target, and it just happens that this interest rate is negative.

The wrinkle is that we achieve this negative interest rate through a settlement cash mechanism – so we need to ask, how do negative rates in settlement cash accounts translate into lending and actual interest rates?

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ECON140 teaching under level 2 preference vote

As noted on blackboard we will need to decide if we continue with these lectures, or move to prerecorded lectures and no in person component . As a result I have popped a vote for this below – we will move to the type of lecture the majority of the class wants.

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ECON141: The cash rate and interest rates

Hi ECON141 students.  Unlike ECON130 there isn’t weekly material on this site, with lecture notes being provided instead.  However, I will add the occasional piece to help give what we are doing some context – so that it can be used to understand what is currently happening.

In that vein, today we are going to talk about how the central bank does influence the nominal interest rate in New Zealand (as compared to our still useful discussion of bond purchases in class).  By doing so we will also be able to ask about “negative interest rates” in a later post.

It should be noted that none of the content I cover here is assessed – you will be assessed on what we do in class and in the lecture notes and readings. Instead the purpose of this is to add a bit more detail about things for students who are interested.

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MPCs, multipliers, and our 1st year ECON model

I have been preparing my lecture content for macroeconomics later in the year, and have thought it would be a bit of fun to finish with the following: discuss why the initial marginal propensity to consumer and the final multiplier on any “initial expenditure impulse” need not be related to each other.

This is an issue that I’d cover after discussing Ricardian Equivalence, and think it matters given the increasing relevance of zero-lower bound economics for students in the current environment – and some of the discussion on NBER about multipliers, and HANK vs RANK (heterogeneous vs representative agent models) models of monetary policy.

Note: These non-standard models are cool, and much more “Keynesian” – but I think the more basic description below is important for keeping us humble about our ability to control things.

Now none of this will go into any detail on the more complex models (and ideas of expectations) – it will just ensure that we aren’t “losing money as an asset from our mental model” and should be read as such.

The circular flow (the description ECON141 is all about) describes the flow of funds around the economy, and the key thing is showing that if there is more dollars going around that flow in a period of time there is by definition more nominal activity – be it through higher prices or higher output. This insight can easily get lost in the discussion of individual channels during the course.

Happy with thoughts below – this is likely to be a non-assessed topic for eager students.

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