Negative interest rates are intended to stimulate the economy. But they might actually do the opposite. Ultra-easy monetary policy “could be the greatest failure of modern central banking,” economist Stephen Roach wrote in a
February 18 op-ed. He might be right. In any case, it’s very hard to find the positives of negative rates. There’s certainly lots of potential danger in these uncharted and troubled waters.
Even so, central banks around the world already have implemented negative interest rate policies (NIRP), including in the eurozone, Japan, Sweden, Denmark, and Switzerland. Lately, Fed officials have discussed negative rates for the US if needed to avert a recession.
Let’s briefly review the latest discussions on the theory and practice of negative interest rates:
(1) Bank profit margins. In theory, negative interest rates should stimulate both the demand and the supply of credit. It’s cheaper for borrowers to borrow, and lenders should be scrambling to get a better positive return on their money from borrowers than a negative one from the central bank. In practice, negative rates squeeze bank margins.
That’s because banks are likely to resist charging their depositors.
Last Friday, the ECB’s Vice President Vitor Constancio said that the ECB would have to “mitigate the effect on banks as other countries have done,”
Bloomberg reported. Of course, he was referring to Japan. The
BOJ recently implemented a tiered approach to negative rates whereby not all banks are “charged” for deposits. Whether the ECB does so or not, Constancio’s comment means that he and his counterparts think bank profits are a serious concern.
The ECB already protects banks’ required reserves from suffering losses, as noted a
WSJ article. But a new approach like the BOJ’s would be more extensive. (See the WSJ article’s helpful chart showing the share of reserves held at central banks in Sweden, the eurozone, Denmark, Switzerland, and Japan under negative, 0%, and positive rates.)
Even so, implementing a negative interest rate policy is not without risk, as an
FRB-SF note concluded: For example, “Japanese banks [are] already squeezed by low interest margins and limited credit demand [and] the risk to earnings is … significant. While expanding overseas might be a natural response to negative rates at home, volatility in key markets like developing Asia along with rising costs of U.S. dollar funding provide a countervailing force, putting banks in a difficult position.”
(2) Spending and saving. In theory, negative interest rates should stimulate investment in risker assets, thus inflating their value, resulting in a positive wealth effect on consumption. In practice, there is a risk that negative interest rates will force many consumers to save more and spend less. There is some evidence that this has happened in Denmark. Needless to say, negative interest rates also increase the risk of asset bubbles.
On the other hand, risk-averse investors and consumers might view negative rates as a warning sign from officials that the economy and markets are weak enough to require non-traditional policies. In Japan, negative public sentiment is causing angst for the BOJ, reported
the WSJ. At a Parliament meeting, an opposition lawmaker attacked the BOJ’s Kuroda: “You have sent a message to the people that they had better watch out because Japan’s economy is in trouble.”
(3) Race to the bottom. In theory, negative rates discourage capital inflows and should depreciate the home currency, which should stimulate exports. In practice, devaluation is futile. There’s only so far that currencies can weaken against others before they trigger competitive devaluations. Such “currency wars” won’t revive overall global economic growth.
On the contrary, they might weigh on it instead. Negative interest rates and currency depreciation are signs that monetary policy can’t solve the world’s economic problems. This week’s cover of
The Economist features a dazed central banker holding a bazooka. The cover story is titled “The World Economy: Out of Ammo?”
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs,
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