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A former Fed official says the U.S. central bank should do the formerly unthinkable: take interest rates below 0%

The Fed’s next policy meeting is April 28-29

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‘Unprecedented situations require unprecedented actions. That’s why the U.S. Federal Reserve should fight a rapidly deepening recession by taking interest rates below zero for the first time ever’

That’s Narayana Kocherlakota writing in an op-ed in Bloomberg Opinion on Friday.

The 56-year-old economist, who served as president of the Federal Reserve Bank of Minneapolis from 2009 until 2015, argues that the U.S. central bank should follow its peers in Europe by taking benchmark rates, which stand at a range between 0% and 0.25% after a series of emergency rate cuts last month, negative for the first time in history.

The former Fed official makes the case that the economic devastation due to responses to curtail the deadly COVID-19 pandemic warrants a shock-and-awe counter by the U.S. central bank.

“Terrifyingly high unemployment and potentially rapid disinflation are powerful arguments in favor,” Kocherlakota said. “Next week, the Fed should take interest rates at least a quarter percentage point below zero,” he said.

On Thursday, data from the Labor Department showed another 4.4 million people filed new jobless claims for the week ended April 18, to push the total above 26 million since the coronavirus crisis laid siege to the U.S. economy a month and a half ago.

The spike in unemployment has likely pushed the jobless rate to between 15% and 20%, some economists estimate. The only other time in American history when unemployment was that high was in the early stages of the Great Depression almost a century ago.

Rates below 0% aren’t far away at current levels, but the Fed has been reluctant to bring interest rates into negative territory, and during the 2007-09 recession they opted to use unconventional measures like buying bonds rather than setting negative interest rates.

During this current viral crisis, the central bank has unleashed an array of stimulus measures to loosen seized up parts of the financial market and to ease borrowing costs for markets, small businesses and households that have been badly damaged by the deadly infectious disease hat emerged in 2019.

The efforts by the Fed have ballooned its balance sheet to $6.6 trillion in the week ended April 22, and is likely to hit $9 trillion by the summer, based on some economists’ estimates.

Against that backdrop, and alongside trillions more doled out by the U.S. government, the Dow Jones Industrial Average DJIA, -1.70%, the S&P 500 index SPX, -1.98% and the Nasdaq Composite Index COMP, -2.10% have risen sharply from bear-market lows hit on March 23.

President Donald Trump has been a big advocate of taking rates subzero, which have prevailed in Europe for years and have existed in a third of the world.

However, there are consequences for taking rates under 0%. Notably, it would become harder — or, at least, expensive — to save money. Banks would be charging negative rates on deposits, meaning that consumers would be paying the bank for opportunity to save money. And the bank’s profits themselves would be hurt.

However, Kocherlakota says that negative rates would stoke consumer demand and encourage banks to lend more aggressively at lower interest rates. The ex-Fed official says that worries about financial stability, the argument that bank shares would be distressed because investors would worry about their profitability, are misplaced in light of the current biological threat that has beset the market and the economy.

The Fed’s next policy meeting is April 28-29, which will conclude with a news conference hosted by Chairman Jerome Powell on Wednesday at 2:30 p.m. Eastern Time. The market is betting that there is no chance for a policy change at that point, based on federal-funds futures, CME Group data show.

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