Gresham’s law needs a corollary. Not only does “bad money drive out good,” but “cheap” money may as well. Ultra low, zero-bounded central bank policy rates might in fact de-lever instead of relever the financial system, creating contraction instead of expansion in the real economy. Just as Newtonian physics breaks down and Einsteinian concepts prevail at the speed of light, so too might easy money policies fail to stimulate at the zero bound. . . .
Zero-bound money – credit quality aside – creates no incentive to expand it. Will Rogers once fondly said in the Depression that he was more concerned about the return of his money than the return on his money. But from a system wide perspective, when the return on money becomes close to zero in nominal terms and substantially negative in real terms, then normal functionality may breakdown. . . .
Conceptually, when the financial system can no longer find outlets for the credit it creates, then it de-levers.