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Source link: http://archive.mises.org/9114/the-inevitable-zero-percent-rate/

The Inevitable Zero Percent Rate

December 16, 2008 by

So now the target for the fed funds rate is between 0 and 0.25 percent. The Bernanke-Paulson plan to try everything that might make things worse, and (incidentally) that failed to help Japan no matter how relentlessly they were tried, continues without interruption.


Justin December 16, 2008 at 3:29 pm

The circus continues. Although, I thought the point of paying interest on reserves was so that the Fed could pump money without lowering the rate to zero. Could someone explain to me why this move is “necessary” (from the perspective of the Fed, that is)?

Michael December 16, 2008 at 3:41 pm

Justin: Why, it’s necessary in order to seed the next speculative bubble which will then burst… repeat.

Lee December 16, 2008 at 3:58 pm

Didn’t the Japanese fail to lower intereste rates as fast? Weren’t their principal problems then relating to the subsequent deflation?

We inflated our way out of the post 9/11 crash, why couldn’t we do so again?

Wouldn’t introducing a 100% gold reserve confine us to continuous deflation? Would continuous delfation not lead to malinvestment similar to continuous inflation; is the object of money not simply to act as median, thus being neither deflationary nor inflationary? History shows that stable prices have been as a result of a fractional reserve, but this, in terms of Austrian logic, means inflation of some kind; are we then confined to malinvestment of some kind?

Why have Austrian economists dismissed Hayek’s proposal of a free-market fiat system so completely?

The Mises institute is the finest of its kind anywhere in the world, however I still am skeptical on a couple of things (above..!)


Andy December 16, 2008 at 4:09 pm


We did inflate our way out of the 9/11 crash, but that low fed fund rate is part of the cause for the housing bubble and its subsequent crash.

The fed artificially sets an interest rate for overnight bank lending. This is no different from a price control (a loan is a product and part of the “price” of it is the interest rate) and price controls only result in waste.

BTW, I loved watching the dollar fall today right when the FOMC announced the rate cut. It fell so fast that on CNBC one of the commentators yelled ” holy crap look a the Euro” right when the FOMC announcement was made. I wish I had money to invest and wasn’t a poor student because I could have made a killing on the Euro today.

Justin December 16, 2008 at 4:13 pm

Michael: True. :)

However, it seems to me that lowering the rate to zero causes the Fed to “lose some face”. This basically confirms that one of their primary tools (controlling interest rates) is now worthless. With their ability to pay interest on reserves, I am curious why they chose to make this concession, when it seems they have all the tools need.

Joe December 16, 2008 at 4:15 pm


The purpose of money is just a medium of exchange. More important than whether a currency is strong or weak is that it is STABLE. The difference between inflation and deflation is that a currency can only deflate so far, whereas inflation has essentially no limit. If we immediately switched over to a commodity backed money then there would be a deflationary period. However, after that the currency would be much more stable than a government fiat whose supply can continuously be expanded by a printing press.

David Bratton December 16, 2008 at 4:42 pm


It isn’t stability that matters most; but rather that the value of the currency accurately reflect the supply of it and the demand for it. Fluctuations in the value of the currency are OK if they are produced by market forces.

Jason December 16, 2008 at 5:12 pm

“It isn’t stability that matters most; but rather that the value of the currency accurately reflect the supply of it and the demand for it. Fluctuations in the value of the currency are OK if they are produced by market forces.”

Guys, it the stability of the currency matters little. Only the fact that individuals are allowed to use whatever money they choose, whether it is “volatile” or not. Liberty is the standard.

Jason December 16, 2008 at 5:12 pm

“It isn’t stability that matters most; but rather that the value of the currency accurately reflect the supply of it and the demand for it. Fluctuations in the value of the currency are OK if they are produced by market forces.”

Guys, the stability of the currency matters little. Only the fact that individuals are allowed to use whatever money they choose, whether it is “volatile” or not. Liberty is the standard.

Michael December 16, 2008 at 5:15 pm

Wow. Check out that dollar dropping. Can’t wait to see the correlating effect on crude with this.

Jon December 16, 2008 at 5:43 pm

I would argue that deflation resulting from a 100% gold reserve system is actually a good and stabilizing thing.

Think about it this way: In a 100% gold system the quantity of money is fixed, thus the only variable is the amount of goods/services that can be produced within society, which would essentially increase as efficiencies in the manufacturing process are realized.

In such an instance, the value of your dollar would deflate meaning prices would go down because each available dollar would increase its PURCHASING power. Volatility, inflation, deflation… the underlying issue here is how much in goods/services will my dollar purcahse. Purchasing power of a currency is all that really matters…

newson December 16, 2008 at 6:05 pm

to jon:
rothbard’s definition of inflation was money supply growth over and above growth in specie. so a gold money with 100% reserved banks could not be deflationary. aggregate prices should fall under this regime via productivity gains, as you say.

Russ December 16, 2008 at 6:17 pm

Sorry but brief history lesson needed here, what happened to Japan when they did this?

Brent December 16, 2008 at 6:31 pm


You are right about the problems of deflation IF you mean deflation of the money stock. You are wrong about “continuous deflation” causing problems IF you mean price deflation stemming from an increases in goods and services. See Mises’ Theory of Money & Credit.

Ball December 16, 2008 at 6:59 pm

The real rate is going to be negative. In other words, the banks are going to have to PAY people to take on more debt!

magnus December 16, 2008 at 7:22 pm

History shows that stable prices have been as a result of a fractional reserve

Prices stabilized by force or manipulation is actively harmful. No one should be in the business of forcibly stabilizing prices, or achieving price stability through currency manipulation.

Prices should be allowed to fluctuate because they are signals of economic reality. Fluctuation of prices is necessary for everyone to know what they need to know about the supplies and demands of goods. Without accurate prices, we have no idea what to buy, what to build, what kind and how much.

You can’t improve economic reality by manipulating prices to be at the level you want them to be. If a business is going bankrupt, editing the accounting records to make it appear profitable will not change the reality that the business is a failure.

The same explanation goes for the economy as a whole — the economy is already faltering, because consumers and producers have malinvested their resources. We were all deceived into the wrong kinds of economic activity by the proliferation of easy-credit (which has been going on for a long time, and only recently accelerated).

Manipulating prices to try to hide the malinvestment that already exists in our economy is nothing but a cover-up for the prior crime.

I prefer to see the true reality, reflected by true prices. Politicians and central bankers manipulate prices because they want us to see their political version of reality. They are liars, in other words.

Jason December 16, 2008 at 7:30 pm

magnus, I couldn’t have said it better. :)

Andrew December 16, 2008 at 8:39 pm

I am reading Fiat Money Inflation in France, my question is: is it necessary to invest in anything besides gold and silver?

Bruce Koerber December 16, 2008 at 9:36 pm

December 16, 2008

Zero Ethics In A Zero Percent Interest Rate!

What Does the Zero Percent Interest Rate Mean?

Bernanke + Krugman = Zero!

Zero interest rate: In the 1990′s Krugman advised Japan to go to a zero interest rate or even to go negative! Bernanke can fulfill his wildest dream of becoming helicopter Ben once the interest rate is zero because then he has only the one option – massive ‘liquidity’ by dumping titanic amounts of dollars as if dropping them from a helicopter.

Bernanke + Krugman = Zero!

Zero knowledge of economic science. Their training is as empiricists but in a field that is subjective. They are like androids with little common sense and no human sensitivities pretending to represent infinitely complex humans who have unpredictable and flexible actions.

Bernanke + Krugman = Zero!

There is not a trace of ethics in either of them and the sum of two zeros is zero!

Darryl Muir December 16, 2008 at 11:06 pm

How does quantatative easing strengthen the US dollar? If the banks build up their reserves with excess money ( and don’t lend) how does this help the economy? Won’t this excess money cause inflation? I read articles from intelligent economists which support the above assumptions. Based on my newly gained interests in the US economy/feds this does not make sense.

newson December 16, 2008 at 11:57 pm

to russ:
the japanese economy stagnated, and both cpi and ppi fell. not because there was no inflation, but rather the money growth fed into multiple bubbles offshore (hello usa). if you want more, do a search under “yen carry-trade”.

bob December 17, 2008 at 1:03 am

i beg to differ with saying that nominal price stability doesn’t matter, although I don’t believe government should aim to create stable prices via artificial means.

To clarify, the monetary unit is essential for economic calculation. If it is perpetually losing or gaining purchasing power, or experiencing volatility of purchasing power, there will be numerous accounting errors as to real profits or losses, and production will err from efficiency. That being said, I think additions to precious metal supplies match much closer to production growth, and that a gold standard would produce such stable purchasing power. Regular, mild deflation (with constant wages and profits) would then represent increases in the standard of living.

The reason the Austrians wish to allow credit contraction and the rapid and harmful deflation that accompanies it, is because we believe that the credit expansion or boom period was actually an unsustainable misallocation of resources based on an incorrect interest rate, and that for the credit system to work properly, it must rid itself of both the artificial credit, and the unprofitable investments that went with it. While this period is indeed not able to function efficiently economically, it will yield the shortest path back to an efficient and sustainable economy.

Continuous credit expansion cannot produce an ever-lasting boom. To do so would require ever-greater amounts of artificial credit to be created. This eventually prevents any real credit from entering the market. In the meantime there will be breakdowns in the capital structure that produce shortages of goods and unemployment and numerous speculative bubble activities that do not add to productive output. Once monetary inflation becomes sufficiently high, the currency itself may be abandoned or experience hyperinflation.

Rasoul Namazi December 17, 2008 at 4:49 am

Would someone help me out here? I looked at Consumer Price Index and it seems we have a 1.0% increase. It seems True Money Supply says the same thing. So I assume that we have Inflation, right? But I see people around constantly talking about Deflation! Am I wrong or mainstream economists are creating another illusion?! Thanks for you help in advance.

Brian Macker December 17, 2008 at 8:05 am


During a “deflation” different prices can move in different directions. The lie of Keynesianism is to aggregate them as if they move in unison. They don’t. Those prices that were run up by the fractional reserver inflation we just experienced will tend to drop first and farthest. Commodity prices always move more because they are more effected by interest rates, as would be housing.

Read Rothbards book “What has the Goverment Done to Our Money” for a starting primer on all this.

Brian Macker December 17, 2008 at 8:10 am


A shift in value of the currency is an important signal in the economy. Austrians aren’t against such signals. What they are against are false signals set up by fiat inflation, or by fractional reserve. Austrians are not for stability of the value of money. In fact one of the premises of setting up the Fed was to “stablize” prices.

fundamentalist December 17, 2008 at 8:52 am

Maybe Bernanke just envies the carry trade that the Japanese enjoyed during the 90′s.

Walt D. December 17, 2008 at 9:22 am

This sound great. Where do I sign up for:
1) A 0.25% mortgage. I can afford $210 a month for a $1 million IO loan.
2) A 0.25% car loan. (Perhaps I don’t need this – GM used to give zero percent financing).
3) A 0.25% credit card.

redshirt December 17, 2008 at 10:32 am

Lee, Good links on sound money (many right back to mises).


A gold backed currency is better in every respect… the arguments against are very well refuted in these articles/chapters/mp3s. I’ll be reading through these for a bit myself. (This one points out some of the errors or deliberate assumptions made that mislead readers: http://mises.org/books/goldstandard.pdf “Costs of..”).

Some of what I’ve learned here: prices should vary for business efficiency / opportunity / demand reasons and not vast variations in the availability of a currency or credit derived from it. (fiat currency + fractional reserve = BIG market bubbles; gold backed free market currency = smaller fluctuations)


(8?» December 17, 2008 at 11:13 am

Walt D., I’m sure there are government forms being designed already as part of Obama’s “Great Leap Forward,” or “New Deal II” or whatever he’s calling it.

Problem is though, advantageous rates will be available only to disadvantaged victims, which will be determined by typical DC pandering. You’ve got to have an “in” to get the goods. Good thing this favoritism is “fair,” huh?

Even worse will be watching the Treasury “manage” rates over time for various political purposes.

Too bad the largest victimized minority class will not be represented, the individual.

Rasoul Namazi December 17, 2008 at 12:06 pm

I want to make sure if I have understood what you say. So in your view, what is important to understand if we have inflation or deflation, is not CPI but True Money Supply. If TMS is rising, we have inflation, if declining we have deflation, rising or declining CPI is not important at all. Therefore, we have inflation right now, because Bernanke is pumping huge amount of money into the economy. I have read Rothbards “Mystery of Banking”, but not “What has government done to our money”. I should start right now, because I hear some strange things from these keynesian economists these days, that I feel completly lost. I see huge amount of money coming out of Fed, but people are talking about Deflation!
Thanks for your kind help.

Mashuri December 17, 2008 at 1:40 pm

Well, since we know how the dice are loaded, we may as well make money off of it. My physical gold and gold mutual funds (401k limits me to only mutual funds) have gained and I’m now shorting treasuries big-time. That’s our current irrational bubble (look at Japan’s QE for reference) and it should pop in 2009.

Michael December 17, 2008 at 2:24 pm

So what’s the Fed chair going to do when this gambit inevitably doesn’t “work”?

“Bernanke became known in some circles as “Helicopter Ben” for his facetious suggestion in that speech that even if the Fed cut interest rates to zero, it could continue to battle deflation by other measures, including dropping large wads of cash from helicopters.”

Source: http://money.cnn.com/2008/12/17/news/economy/deflation/index.htm?postversion=2008121714

bob December 17, 2008 at 3:08 pm

If you want to see consumer price deflation, you need to look at the CPI except replace “owner’s equivalent rent” with the Case Schiller house price index. Currently, rent prices are going up, while housing is going WAY down.

Most of the deflation is in the housing, stock, and financial instruments markets. Producer cut-backs have also led to lower producer prices pretty much across the board; however, a lot of that has to do with the bursting of the oil speculation bubble.

To see CPI with OER vs CPI with the CS index:


Kenneth R Adams December 17, 2008 at 4:30 pm

Can someone tell me in concise form what Mises said would happen at zero interest? Or where i might find that article? Might be good to know what happens from here. Much obliged

Brian Macker December 17, 2008 at 6:04 pm

“I want to make sure if I have understood what you say. So in your view, what is important to understand if we have inflation or deflation, is not CPI but True Money Supply.”

Your question indicates that you completely misunderstood my comments. I didn’t mention True Money Supply so I don’t know why you brought that into it.

CPI is a attempt at measuring price inflation, whereas True Money Supply is a monetary measure, not a price measure. Monetary inflation (not price inflation) could be calculated as the slope (not the value) of the TMS graph.

Your original question was about price inflation, not monetary inflation. The two can move in opposite directions because of another factor, fractional reserve banks.

In my answer I was pointing out that prices for different types of goods can move in opposite directions. Commodity prices can go down as consumer prices go up.

In fact during the inflationary period of the Clinton and Bush early years, the price of housing rentals were going down as housing prices were going up. Seems counterintuitive that what seems to be the same good is moving in two different directions.

What you need to realize is that a rental house and an owner occupied house are two completely different goods. Just like a potato in the field is a different good from one that is in a storehouse, which is different from one on a supermarket shelf, which is different from one in a home.

The CPI has been substituting one good, rental, for another “home ownership” for a long time as Bobs link points out. That underestimates inflation during a fractional reserve inflationary period, and overestimates it during a downturn.

“rising or declining CPI is not important at all”

I didn’t say it wasn’t important. It’s just that it is an estimated aggregate and depends on what you put in the “basket” used to calculate it. Once you realize the causes you will also realize that not all prices are going to fall or rise in unison, nor by the same rates.

Remember also that rising and declining prices are effects not causes, from a monetary standpoint.

There are several types of monetary inflation:
1) Rise in quantities of specie (via mining)
2) Fiat monetary increases
3) Fractional Reserve increases due to lowering of reserves.
4) Local inflation caused by an influx of foreign money via trade surpluses.

Austrians only consider some of these to be true inflations, 2) and 3). The case of 1) would be considered a problem only if massive new quantities of specie were discovered, but then people would probably move to a different commodity as money.

There are different kinds of price inflations:
1) Fiat monetary driven price inflations. (Which are generally permanent). Where the money is injected first will effect the progression of price inflation. Spent on military first will cause military goods to go up first, etc.
2) Fractional Reserve driven price inflations (Which generally reverse after the boom phase of the business cycle turns to bust). This kind of inflation generally effects commodities more than consumer goods.
3) Price inflation due to productivity decreases (the opposite of productivity driven price deflation).

Often the price inflationary effect of one monetary factor can be swamped by another. For instance the Reagan/Thatcher driven world productivity gains should have caused welcome price deflation. Instead, the Fed and other central banks inflated the money supply both by fiat and by lowering standards on reserves (and via margin trading in stocks).

Thus prices went up slowly, instead of down slowly.

Unfortunately this was in the wrong direction, and thus caused the problems.

Michael December 17, 2008 at 9:39 pm

I can’t get this out of my head…

“What we’ve got here is… failure to communicate. Some men you just can’t reach. So you get what we had here last week, which is the way he wants it… well, he gets it. I don’t like it any more than you men. “

Gernot Hassenpflug March 11, 2009 at 2:18 am

Great comments, all.

@bob: I don’t know what Austrian economists think on this topic, but my personal thought is that monetary units are no more essential than any other artifical measure.
Sure, monetary units are nice to have, but at the end of the day an individual looks at his or her situation and decides what best to use as an indicator of growth, profit, risk, etc.
Forcing order into chaos by a controlled anything simply will not work. We can never have full understanding nor control over an economy, so why try?
It is better if we can have a robust chaos about which we know essentials, than a fragile order about which we can get apparently detailed information.

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