by Matt O’Brien
Here is a math problem for the Federal Reserve: What is 3.25 minus 5?
The answer, despite what you might think, isn’t -1.75. It’s that it doesn’t matter what it is as long as it’s much less than zero. Why is that? Because, as we’ll get to in a minute, this tells us where interest rates are probably going to end up the next time there’s a recession, except that this can’t be too far into negative territory. Think about it like this: Rates can’t be much less than zero, since people would just turn their bank deposits that were “paying” them a negative amount — aka costing them money — into cash that wouldn’t pay them anything, but at least wouldn’t cost them anything either. And that’s a lot worse than it sounds. It means the Fed won’t always be able to give the economy the interest rates it “needs.” Instead, the Fed will have to print money or promise not to raise rates for a long time. These things work, but not quite as well as good, old-fashioned interest rate cuts, which is why we’d like to avoid having to use them if at all possible.