WASHINGTON — The idea that interest rates could be “negative” seems so counterintuitive that it defies easy understanding. Yet, here we are. Some foreign central banks (among them, the European Central Bank and the central banks of Denmark and Sweden) have adopted them. No less a figure than former Federal Reserve Chairman Alan Greenspan has suggested that it’s just a matter of time before negative rates come to the United States.
Robert Samuelson
What gives?
It is more than an academic question. President Trump is virtually begging for negative interest rates. He has urged the Fed to drop interest rates to zero; that is a preamble to negative rates. This and other monetary policies are already shaping Trump’s tumultuous relationship with the Fed. Last week, the ECB deepened its negative rates as part of a package to fend off a recession. It is time to see what the fuss is all about.
Negative rates represent another technique by which central banks, such as the Federal Reserve, try to maintain full employment and low inflation. The conventional approach is to raise or lower a “policy” interest rate. In the U.S. case, that is the Fed funds rate, which is the rate on overnight loans between banks. Movements in this rate are assumed to spread to longer-term rates on business loans, mortgages and consumer credit. The shifts stimulate or restrain the economy.
The problem arises when rates have been cut to zero and the economy still isn’t performing as desired. The Fed funds rate can’t be cut further to prod lenders to lend. Negative interest rates are one possible response. The Fed or other central banks would charge interest on the reserves that commercial banks leave at their central banks. For example: Denmark’s central bank charges 0.65% on designated reserves.
The theory is simple. If banks can’t be bribed to lend (through lower interest rates), maybe they can be coerced to lend through penalty payments on reserves. To escape the penalty fee, banks would lend out their reserves. This, it’s argued, would affect other interest rates and stimulate the economy.
What is crucial is that the negative rates on short-term debt spread to negative rates on longer-term bonds that have a larger effect on consumer and business borrowing. This already seems to be happening. At present, there are roughly $16 trillion of negative-yielding bonds out of a global bond market of about $113 trillion, reports the Institute of International Finance, an industry research and advocacy group.
Many factors have pushed down interest rates, said economist Sonja Gibbs of the IIF in an interview. For starters, there are the cuts in official policy rates. In addition, there is heavy demand for safe-haven supplies of bonds — bonds that can be easily sold if there are unanticipated personal business needs. Banks are also big buyers of bonds to satisfy their capital requirements.
For the moment, there is no need for the Fed to resort to negative interest rates, because the Fed funds rate is still in positive territory — 2% to 2.25%. The worry is that if or when the rate drops to zero, the Fed will need some other way to stimulate economic growth. (The Fed’s main decision-making body meets this week and is expected to cut rates to a range of 1.75% to 2%.)
If the case for negative interest rates is so strong, why all the controversy? The answer, of course, is that the case isn’t that strong. Some technical and political factors may impede success, wrote Jennifer McKeown in a report for Capital Economics, a consulting firm.
In some countries — Denmark, Switzerland and Sweden — zero-interest policies seem to have sparked some additional lending, “albeit quite slowly,” McKeown noted. One common fear has so far been muted: the possibility that banks would stage a “flight into cash” to avoid the penalty interest rates on their reserves. This would weaken banks’ profitability without necessarily spurring faster economic growth.
There is also the perverse possibility that the plunge in long-term interest rates would frighten many consumers into believing that their retirement savings are being eroded, leading them to save more and spend less. “If so,” McKeown observed, “monetary policy [becomes] counterproductive.”
What ultimately matters most is the public’s reaction to negative rates. They would be so out of the ordinary that they may be off-putting. Banks are scared that passing along the fees to depositors might trigger a public relations disaster. But if the negative rates aren’t passed along to depositors, their effectiveness in stimulating spending may be minimal.
The larger issue here is barely discussed — the dependence of U.S. economic growth on constant doses of “stimulus,” whether bloated budget deficits, super-low interest rates or negative rates. Their waning effectiveness raises hard questions of whether the economy can achieve adequate growth on its own.
Robert Samuelson is a columnist with The Washington Post.
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