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January 30, 2008


Nathan Smith

There's nothing in principle wrong with negative interest rates. And you could say that even if the lending crisis was induced partly because of low interest rates (and their subsequent rise), there has been so much of a reaction against that that now the danger lies in the other direction, and we need to raise them.

What I'm worried about is the dollar. You don't want your major currencies too volatile. For the dollar to sink this far this fast seems like it could be destabilizing. I can't figure out exactly how, but it makes me nervous.

Of course, a weak dollar can induce higher inflation. And inflation can weaken the dollar further. That could lead to a nasty downward spiral.

That said, this could be a shrewd move, if you figure-- and a lot of the evidence points this way, though it's hard to read the tea leaves-- that the economy is actually fairly healthy but markets were getting spooked into self-destructive behavior. But there are a lot of ways it could backfire.


Yes, I doubly worry about dollar instability in light of such inflationary monetary policy.


Of course, negative real interest rates are a *great* time to run a deficit, if we can do so without creating further instability.

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