JP Morgan Predicts That Fed Will Cut Fed Fund Rates to Zero by January

[RedEarth]

Bloomberg tells us that JP Morgan has issued a report that contends that the Federal Reserve will cut its policy rate to zero by early next year.

While this may prove to be correct, it certainly isn't an obvious move. First, most central banks regard getting below 1% short term rates is dangerous territory. ZIRP (zero interest rate policy) let to a deflationary trap for Japan, and there isn't a particularly good reason to think it will fare better here.

In addition, once short term rates fall below 1%, money market funds have trouble operating profitably. The Fed may find itself not merely acting as a big player in the commercial paper market (money market funds are big buyers of CP), but becoming the ONLY player. That would also not be good.

From Bloomberg:

The U.S. Federal Reserve will probably cut interest rates to zero percent over the next two months to staunch deflation, according to JPMorgan Chase & Co.

The Fed will lower borrowing costs by 50 basis points at each of the next two policy meetings on Dec. 16 and Jan. 28, JPMorgan economist Michael Feroli wrote in a note to investors yesterday. The central bank will hold rates at zero for the rest of 2009 to prevent prices from spiraling down as companies cut jobs and banks reduce lending, stifling spending, Feroli said.

The Fed may not be the only central bank to begin offering free money to jolt life into their recessionary economies and keep prices rising as the 15-month credit crisis deepens. The Bank of Japan cut its benchmark rate to 0.3 percent last month, and the European Central Bank has signaled it's ready to lower rates further after two reductions in the past six weeks.

U.S. consumer prices plunged 1 percent last month, the most since Labor Department records began in 1947, the government said yesterday. Some Fed members indicated a willingness to cut rates to spur growth and keep prices from falling, according to minutes from the last Federal Open Market Committee meeting that were released hours after the price report.

``Taking the target rate to zero percent would not be costless for the Fed,'' Feroli said. Public confidence may drop ``if there is a perception that the Fed has `run out of ammo.'''

http://www.nakedcapitalism.com/2008/11/jp-morgan-predicts-that-fed-will-cut.html

[rockymountaindem]

1. This is going to get a whole lot worse

And yet on another thread here, people are getting all upset at those of us who say we don't have hope. How can I be hopeful when it looks like the first years of my working life any my parents' retirement are going to be crap?

[louis-t]

2. 0.........0?

That's insane.

[Idealism]

3. Japan cut interest rates to 0% for years

And they've been in and out of a major recession for the past decade...worked great!

[lurky]

4. Has a central bank ever offered negative interest rates?

If we were in a deflationary spiral, would that be an option? (Yes, I know, paying people to borrow money is crazy, but so are most of the other hare-brained stimulus plans).

:shrug:

[GliderGuider]

5. Wouldn't that essentially be demurrage?

http://en.wikipedia.org/wiki/Demurrage_(currency)

Demurrage is a cost associated with owning or holding currency over a given period of time. It is sometimes referred to as a carrying cost of money.

Whilst demurrage is a natural feature of private commodity money it has at various times been deliberately incorporated into currency systems as a disincentive against hoarding of money, as well as to achieve other perceived benefits. In particular, with regards to long term investment financing it has the effect of changing the dynamics of Net present value (NPV) calculations. All else being equal, a currency system with demurrage places an increased emphasis on the value of long term returns on an investment. As such it may create an incentive to invest in initatives which offer more in the way of longer-term returns.

Demurrage also has an effect nearly identical to inflation, but without the same underlying causes. When multiple currencies are being used, Gresham's law suggests that a demurrage fee would help a currency achieve more rapid circulation. Even if only one currency is being considered, demurrage would likely increase the velocity of circulation of the currency, encouraging economic activity.

One could also view demurrage's effect as being similar to negative interests rates. However, unlike interest, it applies to all currency in circulation, not just that which originated as a loan.

Increases the velocity of money? Acts like inflation? This could make demurrage an interesting antidote for a deflationary depression. I wonder if anyone will have the balls to try it...

[lurky]

7. Thanks for the link! It seems like the problem with negative interest

would be that banks would just borrow the money, sit on it for a while, and pay it back at a profit, without actually loaning it out to stimulate the economy. If I understand demurrage correctly, it wouldn't have the same potential for abuse.

[girl gone mad]

6. No surprise.

I predicted the return of zirp last month.

[GoesTo11]

8. I so wish I could earn 0% on my money

instead of -6% every day. Goddamn it.