Having surprised markets with extraordinary credit easing, the Federal Reserve was hoping for a quieter period in which reduced financial volatility would allow for more of the heavy lifting to be shifted to other policy makers and markets. Instead, in a repeat of a too-familiar pattern, the markets are asking for more.
Forward-looking indicators have been flirting with the possibility of negative interest rates by the end of this year or the beginning of next year. This is happening despite repeated statements by Fed officials that negative rates are unlikely and undesirable – and for good reason. The experience of Europe with negative rates suggests that the benefits are not only small, but they may well be offset by multiple costs and risks — from damage to financial intermediation to economy-wide misallocation of resources.