Why Negative Rates Could Spark Recession


When global markets are in turmoil, the last thing you want to hear from the person in charge of U.S. monetary policy is that she’s surprised.

In testimony before Congress last week, Federal Reserve chairman Janet Yellen said they had not anticipated the strong U.S. dollar and were also surprised by the precipitous drop in oil prices. It’s sort of hard to believe that the Fed was caught so off guard by conditions that had been brewing for so long.

That was not what any of us expected to hear, considering the recent market volatility, relatively weak corporate growth outlook and bearish major market indices in 2016. I would imagine that Yellen’s not too pleased with the timing of all that bad news either, what with it being an election year and all.

But if the Fed’s apparent lack of foresight was at all concerning, that was just the tip of the iceberg. When asked about the legality and possibility of taking interest rates into negative territory, as central banks in Europe and Japan have done, the Fed head was surprisingly open to the idea, despite it never having been tried here before.

"In light of the experience of European countries and others that have gone to negative rates, we're taking a look at them again, because we would want to be prepared in the event that we would need to,” she said. “We haven't finished that evaluation. We need to consider the institutional context and whether they would work well here. It's not automatic."

It’s not automatic. Good to know that taking U.S. monetary policy into unknown and potentially treacherous waters where the law of unintended consequences might wreak havoc on our anemic economy isn’t automatic. Gee, she had me worried there for a second.

Let’s recap. Here’s my summary: Having shown surprisingly poor judgment and missed a ridiculously long window to raise rates to something resembling normal during the admittedly weak recovery from the last recession, the Fed left itself absolutely no wiggle room to lower rates when the next one comes along.

Then, having failed to anticipate that the sky was about to fall, the Fed in December exhibited spectacularly bad timing in implementing its first rate hike in nine years just before the global financial markets fell off a cliff. And sure enough, now everyone is talking recession.

Look, we don’t’ need Nostradamus running the Fed; none of this is rocket science. You could see it coming a mile away. And now, Yellen is thinking about the unthinkable and considering doing what’s never been done before. I guess she thinks corporate America and investors don’t have enough chaos to deal with.

Don’t get me wrong. I’ve never put much faith in economists. They like to pretend that macroeconomics is a science when it’s not. In reality, it’s just a bunch of central bankers experimenting with currencies and interest rates under conditions that will never occur again in the history of the world.

There are simply too many variables and too little control to determine causality between action and outcome. That’s why we still have no idea whether the great quantitative easing experiment helped or hindered the recovery. Not even a clue.

Of course, Yellen’s comments on negative rates have raised all sorts of questions to which there are no answers: What are they and how will they affect banks, markets, and individuals? How have they worked out in Europe? And if it really is an instrument worth considering, then why, pray tell, has it never been done before?

I’ll tell you why. It reeks of desperation. You don’t have to be Sigmund Freud to know that’s not a good thing when global markets are already in a state fear and anxiety. It’s just bad psychology.

As the largest economy in the world, America is still viewed as the economy of last resort. And while negative interest rates may not be the boogeyman some make it out to be, that’s not going to matter one bit when everyone’s running around like economists with their heads cut off clucking about what effect it might have.

Never mind that negative rates are supposed to calm fears. Never mind that they’re supposed to get people to buy and banks to lend. Never mind that they’re supposed to prop up markets just as low interest rates have done. The problem is that market behavior is emotional. Markets react to fear. And anything untried stokes fear.

The last time markets were this volatile was 2008. With talk of another global financial crisis so soon on the heels of the last one, the Fed taking interest rates into negative territory to keep us out of recession just might have the opposite effect.

The Fed never should have gotten us into this mess in the first place. And now that we’re here, there’s simply no reason to even consider pushing that panic button.