Negative Interest Rates – Are There Any Positives?

Yves here. I’m a bit mystified that central bankers were so confident that an untested experiment like negative interest rates would work out as planned, particularly since some of the assumptions as to why they thought it would work seem utterly barmy. But this is what happens when you put stock in theories that were debunked (by no less than Keynes), like the loanable funds model, that mainstream economists treat as gospel.

First, monetary authorities contended they could pressure consumers into spending more by penalizing cash holding. But they can only punish holding cash at banks. Since consumers are perfectly capable of withdrawing cash and storing it in mattresses, and central bankers don’t want to precipitate slow-motion bank runs, in practice they can’t go very far at all in that direction.

Second, they seem to believe that making lending rates lower will lead to more borrowing, and thus will stimulate the economy. But we’ve had years of negative real interest rates and anyone who is a reasonably smart investor knows that. So we’ve had lots of people borrow and speculate (buybacks, Silicon Valley unicorns). By contrast, real economy investors invest and expand based on the prospects for their venture, which means demand for their products and services. Save for industries where the cost of money is one of the biggest costs (finance and real estate), the level of interest operates at most as a constraint to investment, not a spur.

And as far as consumer borrowing is concerned, banks don’t necessarily pass on the further rate reductions to consumer rates. And even if they do, most consumers won’t borrow. First, many are still trying to delever, or save more given how lousy returns on investments are. In addition, many may recognize that negative rates equals deflationary expectations. In deflation, you do not want to be indebted, since the real cost of debt rises. You want to hold cash, cash equivalents, and high quality bonds. Finally, high levels of consumer borrowing is a drag on growth. Why do advanced economies want to encourage it?

Third, after central banks have made such a fetish of setting inflation expectations, how can they have convinced themselves that moving into negative rates sets all sorts of negative expectations? It signals that central banks are desperate, which is not a plus for confidence. It signals deflationary expectations. And that reinforces what citizens are experiencing: wage pressures, benefit cuts, shorter job tenures. The monetary authorities are flashing a big red warning to expect even more of the same. And they expect businesses and consumers to borrow and spend as a result of their fiddling with the dials? Help me.

By Steve Worthington, Adjunct Professor, Swinburne University of Technology. Originally published at The Conversation

Some say that economics is “the dismal science” and perhaps this is because many economic theories do not seem to work in practice. One contemporary example is negative interest rates, where instead of interest being added to their savings, individuals find that value is lost.

Negative rates have been introduced by some central banks worldwide. In theory doing so should both devalue their currency, making their exports cheaper and imports more expensive, and at the same time encourage consumer spending. It should also boost lending by financial institutions, as the value of capital being held by both individuals and banks is ever decreasing.

Sadly this theory when put into practice has been found wanting. The Bank of Japan introduced a negative interest rate of minus 0.1% in January 2016 and the yen subsequently increased in value compared to its competitor currencies. Indeed in 2016 the yen is the best performing G10 currency against the US$.

Similarly the Swiss National Bank flagged a negative interest rate of minus 0.25% to be introduced in January 2015, but the inflow of funds into the Swiss franc continued and the rate was finally reduced on its introduction to minus 0.75%, with the aim of discouraging capital inflows. However despite these moves the Swiss National Bank continued to accumulate foreign exchange reserves into the second half of 2015.

The European Central Bank (ECB) further increased its negative interest to minus 0.4%, on bank deposits held at the ECB in mid March 2016, as it attempted to manipulate downward the value of the Euro. The impact of this was undermined somewhat by allowing the European banks to borrow from their central bank at the same minus rate, depending on how much they lend to businesses and consumers. An initial dip in the value of the Euro when the minus 0.4% was announced was then followed by a sharp rise, as the implications of the whole package became clearer.

The aim of this is to lower the cost of borrowing for both consumers and corporations, as the banks borrow money from the ECB at no cost to them. This is intended to help stave of the threat of deflation in the eurozone by stimulating investment and consumption.

Recently published research from the Bank for International Settlement (BIS) found that in some cases savings accounts had been insulated from the impact of negative interest rates and that some mortgage rates in Switzerland had “perversely increased”. The conclusion from the BIS was then,“if negative interest rates do not feed into lower lending rates for households and firms, they largely lose their rationale”.

The Governor of the Bank of England has argued that if central bank policies are structured in ways that shield retail bank customers from minus interest rates, then they are unlikely to do much to stimulate domestic demand. Instead the main effect will be on exchange rates and this will result in the provoking of currency wars, as central banks attempt to out do each other in negative interest. Negative interest rates are intended to boost domestic demand by forcing banks to lend money out and encouraging consumers to both borrow and spend.

Consumer Behaviour is Unpredictable

Once again the “dismal science” comes up against the unpredictable behaviour of individuals and organisations, when they enter the territory of negative interest rates.

Take Japan in February 2016. One month on from the Bank of Japan’s decision to unleash negative interest rates, applications to join the loyalty clubs of Japanese department stores such as Mitsukoshi, Daimaru and Takashimaya were 100-200% higher than in the same month of 2015. The explanation is that these loyalty clubs offer a 5 to 8% annual bonus to their members, a far better return than any Japanese bank can offer, even if it encourages them to spend their money where they have their account(s).

So will negative interest rates continue to be used as a weapon from the central bank armoury, or will the unpredictable behaviour of consumers and investors undermine the intentions of the central banks?

If the weapon of negative interest rates does not work as expected on currency values or domestic consumption and investment, what else is there left to deploy to prevent deflation and a further slow down in economic actively? Economics indeed truly is dismal science.

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  1. Larry

    How about redistribution of income and fiscal stimulus to put the brakes on deflationary pressures? Most the G10 could use a serious boost to infrastructure in terms of both repair and upgrades. But that is too politically “difficult”, so we have the dismal scientists contuing to run their failed experiments at central banks instead of sensible policies.

  2. Moneta

    Japan had a huge competitive advantage which gave them a couple of decades of respite but this lead has been eroding.

    Many countries will not be able to maintain negative rates for too long without destroying their economies. If your exports are under pressure and you need to import resources and energy, good luck with using NIRP to lower the value of your currency. It will be a game of musical chairs.

  3. Sean

    One thing I have a worry about NIRP – it makes war cheaper.

    And we all know that Congress will approve war funds way faster that they will for any infrastructure bill.

    1. Jim Haygood

      Free money, free war.

      That’s what Woody Wilson found out, when he foolishly capitulated to the Jeckyl Island conspirators on 23 Dec 1913.

      Now we have permanent war finance and permanent war. The system works!

      1. Skippy

        Hay Jim I thought we cleared up the scary Jeckeyl Island campfire story’s way back as creative writing exercises for CT authors.

        That Hayekien paranoia or underlining Judaic – Christian money crankery…. watch out for the first step mate…. you’ll never stop falling…

        Skippy…. I don’t care about your personal delusions personally…. its just when you attempt to take others with you…

      2. MyLessThanPrimeBeef

        Not war, but peace-making.

        Free money, free peace-making.

        By the way, is this true:

        Free love – if love is free, you are the product.

        Why not? Let me be the product.

      3. Plenue

        Wow, seriously? You’re talking about the Aldrich Plan, which died in Congress. Twice. I wish MWD (I think that was his handle) still posted, so he could tear you a new one.

    2. susan the other

      after stanley fischer contemplated publicly about a possible negative rate, at least one wag on CNBC said the only reason to go NIRP was to make the national debt interest payments affordable and thus the Fed would never raise % much. ever.

    3. cwaltz

      Sadly, it’s the only government spending they can’t get enough of.

      Cue the mockery of Bernie Sanders for wanting to spend money on things like education, health care, or anything of value that isn’t a bomb or dedicated to decimating things.

  4. Adam1

    Negative interest rates is just utter proof of how out of touch economist are (who also run most central banks) with how actual banking works. Yes, banks have reasons to acquire deposits but lending and deposit taking are completely separate operations. Negative interest rates are applied to reserves held at the central bank. Those funds only have limited purposes – to buy currency and coin as demanded by customers; to lend to other banks short reserves; to buy newly issued government securities; and to clear and settle payments between banks. No bank wishes to hold any more reserves than absolutely necessary. In fact in countries like Canada where there is no reserve requirement – absent QE the banking system ends each day with basically a zero balance of central bank reserves. Excess reserves are purely a function of central bank policy and to charge a negative interest rate is equivalent to a tax increase on the bank. I don’t see how increasing the cost structure of the bank leads to more lending or to more spending by consumers. And while I am at it, the logic on the consumer side is as crazy as on the lending side. People save for a reason. However your mainstream economist just assume that because a bank can pass their cost of negative interest rates onto the consumer, that said consumer all of a sudden just forgets about their reason for savings and decides to spend their money instead. As a consumer if I need to save $10000 for something and my ability to do it goes down (because of negative deposit rates) I now need to figure out how to surmount that new obstacle. As Yves pointed out I can always stuff it under the mattress, but if that’s not an option then I will need to DECREASE my other personal consumption to make up for the gap. Negative interest rates are a tax on the economy, but in the imaginary world of most mainstream economists it is exactly the opposite.

    1. jrs

      “People save for a reason. However your mainstream economist just assume that because a bank can pass their cost of negative interest rates onto the consumer, that said consumer all of a sudden just forgets about their reason for savings and decides to spend their money instead. As a consumer if I need to save $10000 for something and my ability to do it goes down (because of negative deposit rates) I now need to figure out how to surmount that new obstacle.”

      That’s how it worked in Japan, but they had a culture of saving, the U.S. not so much, so who knows. But short of a Scandinavian system or better where many emergencies are taken care of collectively and one saves mostly for wants not needs (and this does work better of course), it doesn’t tend to work for individuals to not save.

      1. reslez

        Japan still has a substantial proportion of single earner households. The US had a “culture of saving” for as long as wages were able to support it. When that changed, women entered the workforce and consumer debt took over. In the US, economists frequently confuse saving for paying down debt. They scratch their heads in befuddlement when the citizens don’t spend every penny of earnings on buying stuff. But when uncertainty rules, your highest priority is paying down debt. Buying stuff is a distant sixth (behind other necessities like housing, health care and education… all of which are out of control).

  5. Jesper

    Well, practitioners of the dismal science are arguing for cost-inflation without wage-inflation (we have to be competitive…). Increased costs and reduced (wage-) income is somehow expected to lead to increased spending?
    & then we have the trade-agreements… They are expected to lead to decreased costs, also known as deflation, but these decreased costs (deflation) aren’t bad?
    & would/should a bank lend to people in insecure employments? The kind of employments that practitioners of the dismal science argue are good for the economy and we should have more of.

    As for the unpredictability…. Practitioners of the dismal science might not be able predict something but that does not mean that thinking people can’t predict the outcome.

    EMH and MMT both work in theory but in practice they seem to encounter the same problems: Humans not acting rationally, agency problems etc.

    1. different clue

      What is “not rational” about individual humans wishing to protect themselves against any NIRP attack against their savings launched by their OverClass Governnators? If these individual humans targeted for a NIRP attack live under a system beyond their collective political power to affect, what is “not rational” about all these humans seeking what personal individual escape they can from the effects of these NIRP attacks against their savings-placed-in-officially-sanctioned institutions?

      Such humans in such a circumstance will begin with self-preservation and then share self-preservation knowledge and assistance with other humans in the same circumstance. That becomes the start of a culture of resistance on the part of society-loads of humans all experiencing the same NIRP-attack ripoff of their savings.

      I am just a layman surviving in this society to be sure, but I wonder why a NIRP attack on savings would affect the savers any differently than a Consumption Tax attack on the survival earnings of non-rich 99 per centers? Especially because in this OverClass-ruled society, such attacks would begin against Dollar One of the poorest and then work their way up the ladder to a cap set by the OverClass to hold the One Per Cent harmless to such policies. Don’t worry, the OverClass would find a way.

      The one good thing to say about such regressive tolls and taxes against the 99 per center majority is that it would lower and discourage consumption and production enough so as to shrink economies violently and drastically to ecologically sustainable size. One wishes a more humane way would be found to do that.

  6. cnchal

    . . . And they expect businesses and consumers to borrow and spend as a result of their fiddling with the dials? Help me.

    They do not understand the concept of creating a product and serving customers in an exchange that is not coerced.

    . . . The Governor of the Bank of England has argued that if central bank policies are structured in ways that shield retail bank customers from minus interest rates, then they are unlikely to do much to stimulate domestic demand.

    Carney’s blarney drives the point home.

    So will negative interest rates continue to be used as a weapon from the central bank armoury, or will the unpredictable behaviour of consumers and investors undermine the intentions of the central banks?

    A better question is, will the unpredictable behavior of the useless eaters undermine the intentions of the little people. The answer is in, and it’s yes.

  7. vlade

    Yes, there is one. Some “Serious People” are finally starting to realise that w/o fiscal policy changes recovery ain’t gonna happen anytime soon (if ever). In 2007 I predicted that at best, we can expect the next decade to imitate Japan.

  8. ke

    Monetary policy is a function of FIRE, RE control, which is a function of demographics, an actuarial insurance ponzi, from which people with functioning synapses exit.

    Fiscal policy is function of compliance, a positive feedback loop, maintaining the bankrupt financial enterprise. The critters running the operation have no real work experience, so they have no idea how to distribute the money and can only comply in any case, always resulting in a bridge to nowhere.

    A century later and the best they can come up with is a battery factory. It’s always religion, so the simplistic response is discounting the money, which is exactly what happens, History.

    The cbs subject themselves to DNA momentum.

  9. ke

    Complimentary charge; quantum porosity; differentiation, dedifferentiation, and redifferentiation. Build the antenna.

    Beware May.

    1. craazyman

      Kevinearick can write one sentence and stop? This is certainly a new phenomenon! :-)

      What about do-re-me-differentiation?

      1. ke

        Another sentence:

        Earth bias is a wavelength of 18000 miles, which critter bodies pick up. Life from rock lattice.

        What happens to the critter biodome on Saturn or the next galaxy over?

        Craazyman come long way.

        1. craazyman

          If you ain’t got the dough re mi, boys, if you ain’t got the do re mi
          Why, you better go back to your beautiful day job$, in Oklahoma, Kansas, Georgia, Tennessee.
          Andromeda’s a garden of Eden, Saturn’s a paradise to see
          But believe it or not, you won’t find them so hot
          If you ain’t got the dough ray me

          -Woody Guthrie – Do Re Mi (kind of)

        2. ke

          Money is a political phenom, of health and education breeding, willful ignorance as the precursor to perpetual war, do=re=me.

  10. Jef

    As I have commented before IMO central banks always act from behind the real economy. They can goose a growing economy, or they can hobble it.

    No growth and CBs are impotent.

  11. Expat

    Yves, your point about negative interest rates failing to work because people will simply hold cash at home will be covered by the government. Indeed, this is already well on its way in Europe. Cash is being banned. No cash, no hoarding. Simple.

    In France the limit for cash transactions is 3000 euros. It is illegal to buy gold or silver in any amount with cash. 500 Euro notes are being eliminated Europe-wide. Banks won’t change €500 notes; you have to deposit them. Businesses accept them still but not very happily or easily.

    Banking will go the way of healthcare. Every American will be required to have an account at a TBTF bank. Since it is electronic, they can charge you whatever interest rate they want. Ultimately, there will be spending requirements like having to replace your washer every two years or outlawing cars over seven years old. Scoff at these things if you want, but think about the crap they have put in place over the past fifteen years and ask yourself if these measures are really unthinkable.

    1. cwaltz

      When they do stuff like this all it does though is create an underground economy- which just happens to be how many of the nations in financial trouble like Greece or Italy wound up in financial trouble to begin with.

      You can force a person to have a bank card but you can’t force them to use it and if you create a network of rules that don’t work to the advantage of the majority, they will innovate ways around them.

      1. different clue

        Perhaps by going so far as to store and stockpile US currency bills and coins against the day when the FedGov “pulls a Yeltsin” and declares the “old currency” to be exchangeable at a major loss for the “new currency” until date certain X; after which the “old currency” will be declared worthless.

        If enough millions of USians have enough millions of “old currency” bills and coins, they might be able to form very large and extensive “hybrid black markets” consisting of barter and sale/purchase of things and work for “old currency”. Even if some future FedGov “pulls a Yeltsin” and declares the “old currency” is no longer Legal Tender, millions of Black Market Patriots may well regard their legacy “old currency” as Moral Tender between and among themselves. They will discover whom they and eachother are. And they will do bussiness outside their own Patriot Black Market social circles in the Yeltsinite FedGov’s “new currency”. The “old currency” will retain Moral Tender status among and between members of the Patriot Black Market community.

  12. pebird

    When my car loan pays me interest, you can call it negative interest rates. Until then call it deposit fees.

  13. susan the other

    yes there is a positive to negative rates. i think. it comes in the form of a reversal of economic practice. the goal in future for all enterprises on this planet, commonly referred to as economix, is no longer profit and monetary gain so everybody can go out and do it all over again. for more profit and gain. the goal will be cleaning up the planet – if we want to survive. since there is no profit to be had in environmental cleanup, unless we want to create even bigger instabilities than we have now, the best substitute for incentive will be getting free loans which amortize the cost of cleanup by paying down loans for all intrepid entrepreneurs, and that includes expenses like payrolls so the grassroots are fed. it could work beautifully in a world of no growth/no extraction. we need negative business models. it’s not socialism, it’s reverse capitalism. ;-)

    1. jrs

      It’s capitalist to defend interest, if you are anti-capitalists you probably want to find a way to get away from it, at least in ideal, even if it won’t happen in practice. Why earn money just for holding money? It makes no sense and it’s unjust.

      Money (or the things money can buy) from labor or money as part of being part of the society, now that makes sense. But the world being what it is now, and brutal, people will pursue interest on any money if they have it, and can’t get away from paying interest if they borrow and are joe schmoe rather than a bank. In fact in the world at present negative interest on the savings account would mostly seem to hurt the 99s if anyone.

  14. John

    While the Post-Keynesians/MMT people are some of my favorites, ultimately they don’t have the solution for the crisis, either. Fixing America’s infrastructure would boost demand in the short-term as well as help generate some economic activity, but it’s certainly not enough to get us out of the predicament in which we find ourselves. Ailing American infrastructure did not cause the entire global economy to hemorrhage the way it has, so fixing it will not solve the structural contradictions that caused this crisis to begin with.

    Sure, the popping of these big asset bubbles was the trigger and it took out quite a bit of demand, too, but clearly their were underlying problems with the real economy. The fact that we’ve had such low growth rates since the 1970’s despite having huge asset bubbles shows how poor the performance of the real economy has actually been. Industry is the heart of any real developed capitalist economy (finance can carry maybe one really big city but nothing more), and the more technology (efficiency/productive capacity) advances, the more industry shrinks. Profit rates in manufacturing around the globe have been steadily falling, and this is seriously impeding the normal functioning of capitalism.

    Japanese (or European) stagnation is the future. Neither capital nor the public will like the low growth rates, and we’ll see all sorts of wacky government policies to try and “fix” things: NIRP, huge government deficits, attempts to devalue currencies (Japan is trying all three to no avail). Yet none of these measures can ultimately restore profit rates in manufacturing. And since there’s no free lunch, at some point we’ll pay the longer-term consequences of these short-term stabilizers. When we get a real depression, the political center will begin to vanish and the left and right will battle to decide the fate of the once ‘developed’ world.’ It’s already happening. The right will find allies in the now unpopular but wealthy centrists–most middle and upper class liberals turn fascist in a heartbeat if it spares them from the alternative–but eventually the failure of either to deliver normal growth rates will cause the people to wonder if a better system exists.

    Of course a world war would totally change things and the rebuilding process would offer huge opportunities for economic growth. Alternatively, drone technology (and maybe a dose of virtual reality as well) could keep the masses from ever being able to overthrow the system. So we better get started.

  15. Alejandro

    The authority to tax comes with the power to tax, and taxes have never been optional. As disturbing as the historical imagery of enforcement has been, it doesn’t change the fact that taxes drive demand for the currency. From my POV, fiscal policy can do what monetary policy can’t, which is regulate AND modulate demand for (and supply of) the currency. IMO, this authority and power ultimately depends on consent, though some believe it comes exclusively from enforcement.

    Good and bad are relative terms and therefore depend on context…“democracy” is often touted as the arbiter, but “we” can’t seem to agree on what it “is”, what “it” means, what “it” can and cannot do…IMO, the quid pro quo of consent should be accountability…elections are “supposed” to legitimize consent, but if corporate media can “manufacture consent” as opposed to real journos informing and “reps” demanding accountability, then how legitimate are election results?

  16. Andrew Anderson

    “But this is what happens when you put stock in theories that were debunked (by no less than Keynes), like the loanable funds model, that mainstream economists treat as gospel.” Yves

    Banks don’t actually lend. In fact, it’s impossible for a bank to lend (unless it resorts to physical fiat, aka “cash”) except to other account holders at the central bank, typically other depository institutions.

    Instead, a bank “lends” by creating additional liabilities to its fiat account balance at the central bank and to the physical fiat, aka “cash” it has in its vault (“vault cash”).

    Now creating additional liabilities to fiat is and should be dangerous, one might think, but not so much for the banking cartel.

    Instead by “virtue” of deposit insurance provided by the monetary sovereign and because only banks and other depository institutions may have accounts at the central bank (thereby constituting a government-privileged cartel), the liabilities a bank creates when it “lends” are largely* a sham except toward other account holders at the central bank.

    So the banks don’t/can’t lend except among themselves and the liabilities they create are largely* a sham except among themselves.

    *Only “largely” because physical fiat, aka “cash”, still exists. If/when physical fiat is abolished then the liabilities of the banking cartel toward the rest of the private sector will be entirely a sham. Conceptually, that will make things very clear since then absolutely no one in the private sector except banks and other depository institutions with accounts at the central bank may use their Nation’s money, fiat!

  17. MaroonBulldog

    Suppose, hypothetically, that you owned a small plot of land, and trespassers came, pitched a tent there, and started cultivating a vegetable garden on your plot of land, to grow vegetables for their own consumption, but none to share with you.

    Would you be willing to pay rent to the trespassers while they continue to occupy your plot of land, depriving you of the use of it? Can you conceive of any system of justice that would call upon you to do so?

    If you can make the case for paying “negative rent” to trespassers who disposses you from your plot land, then I suppose you can understand the case for paying “negative interest” to bankers who detain your money. Because that’s what interest amounts to, compensation paid to you by others who have detain your money.

  18. Disturbed Voter

    With the Dollar being currency of choice, and its value growing against other currencies, the negative interest rates are for all other countries, to try to improve their competitiveness, not only for bilateral trade in their currencies, but also as currency holdings by other countries. Why keep Euros or Pounds if their value is falling vs the Dollar?

  19. vegeholic

    Isn’t NIRP just the beginning of a wealth tax? Everyone taxes your income, and local governments tax your real property but the rest of your wealth has always been yours to keep. I see that Connecticut is going after the $25B Yale endowment. Notwithstanding Grover Norquist, I just see large stores of untaxed wealth as looking more and more attractive to people in positions of power.

  20. different clue

    The people in power work for the people who have large stores of personal or dynastic family wealth. Their wealth will not be taxed until their ownership of the governators is broken. The only large pools of money which will be attacked under the current regime are those made up of millions of aggregated small holdings belonging to the 99 per cent . . . . 40Whatever-Ks, Social Security, Pensions, etc. Those are the pools which the 99 per centers will have to defend and protect.

  21. KPL

    “central bankers don’t want to precipitate slow-motion bank runs”

    With so much excess reserve in the system that banks do not want deposits (e.g. RBS), how do you get a bank run – theoretically they have the money to pay out depositors…

    1. Yves Smith Post author

      1. The UK does not have negative rates.

      2. I suggest you bone up on Italy, which is already undergoing a slow motion bank run.

      3. The ECB has designed its policies in an effort to shield deposits, so they clearly see this as a risk.

      1. KPL

        Alternative bank Schweiz has implemented negative rates on current account. No bank run there looks like… at least no news about bank runs there that I have seen.
        My point is if one can do it and there is no bank run, it means others are likely to do it. Also as the rates go negative (CBs work) at some point it will get passed on. I agree that the risk of a technical bank run (depositors pulling out money all at once) exists but can it bring the bank down given the excess reserves they have or deposits they seem to be able to lay their hands on?

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