Between the cup and the lip : On Post Keynesian interest rate rules and long-term interest rates management

This paper has been presented at the IEPI-Laurentian U. conference: 'The political economy of central banking', Toronto, 27-28 May 2009. It provides substantial developments of the main ideas contained in a previous paper prepared for the Post Keynesian Economics Study Group workshop: Inflation targeting: is there a credible alternative? Balliol College, Oxford, Friday 4 April 2008 (rewritten in association with M. Hayes and published as "Post Keynesian alternative to inflation targeting", Intervention, 6 (1), 67-81.).The paper states that, although Post Keynesian interest rules may be feasible and sustainable in favourable circumstances, there is a shared difficulty as for the setting of long-term interest rates in a context of strong uncertainty and shifting liquidity preference. According to Keynes theory of the interest rate, the variation in the long-term interest rate that authorities are seeking for must correspond to the market convention, in order to preserve the state of the confidence and avoid disruptive shifts in the demand for money. It is argued that authorities should therefore announce a long-term interest rate target in accordance with the normative objective the opinion has debated on and agreed with. Also, such a conventional target cannot be very distant from the current rate, and the short-term rates authorities control should be adjusted gradually (but not slowly). Moving the interest rate convention is harder to get in the context of the current crisis, because of the deleterious effects on private and public accounts, and thereby on the state of confidence, that the innumerable amounts of bad debts have carried. We put forward strong arguments in favour of reducing the amount of bad debts by means of temporary large public deficits and accommodating monetary policies (which is not to say permanent large deficits and inflationary policies), even though long-term interest rate do not respond much to the short-term impulses of central banks