Negative interest rate policy (NIRP) and the fallacy of the natural rate of interest: Why NIRP may worsen Keynesian unemployment

NIRP has quickly become a consensus policy within the economics establishment. This paper argues that consensus is dangerously wrong, resting on flawed theory and flawed policy assessment. Regarding theory, NIRP draws on fallacious pre-Keynesian classical economic logic that asserts there is a natural rate of interest which can ensure full employment. That pre-Keynesian logic has been augmented by ZLB economics which claims the natural rate may be negative in times of severe demand shortage, so that policy must deliver it since the market cannot. In contrast, Keynes argued investment could become saturated so lower interest rates cannot increase aggregate demand (AD) and no natural interest rate exists. Regarding policy assessment, NIRP turns a blind eye to the possibility that negative interest rates may reduce AD, cause financial fragility, create a macroeconomics of whiplash owing to contradictions between policy today and tomorrow, promote currency wars that undermine the international economy, and foster a political economy that spawns toxic politics. Worst of all, NIRP maintains and encourages the flawed model of growth, based on debt and asset price inflation, which has already done such harm.

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