For some time, we’ve maintained that negative interest rates would fail at achieving their intended results, which was to stimulate spending. Honestly, it beggars belief that economists could have convinced themselves of that idea. As we’ll discuss, the Swedish central bank has just thrown in the towel on them.
We’ve heard for years that the Fed had privately come to the conclusion that its experiment with super low interest rates was a bust, even though it still hasn’t figured how to move away from them to a more normal rate posture. In keeping with that line of thinking, the Fed had also concluded that negative interest rates were a bad idea and was unhappy that other central banks hadn’t figured that out. The Fed’s distaste for negative interest rates was finally made official with the release of FOMC minutes saying as much last month.
One of the many times we debunked the official rationale for negative interest rates was in a 2016 post, Economists Mystified that Negative Interest Rates Aren’t Leading Consumers to Run Out and Spend. We’ll hoist at length:
It been remarkable to witness the casual way in which central banks have plunged into negative interest rate terrain, based on questionable models. Now that this experiment isn’t working out so well, the response comes troubling close to, “Well, they work in theory, so we just need to do more or wait longer to see them succeed.”
The particularly distressing part, as a new Wall Street Journal article makes clear, is that the purveyors of this snake oil talked themselves into the insane belief that negative interest rates would induce consumers to run out and spend. From the story:
Two years ago, the European Central Bank cut interest rates below zero to encourage people such as Heike Hofmann, who sells fruits and vegetables in this small city, to spend more.
Policy makers in Europe and Japan have turned to negative rates for the same reason—to stimulate their lackluster economies. Yet the results have left some economists scratching their heads. Instead of opening their wallets, many consumers and businesses are squirreling away more money.
When Ms. Hofmann heard the ECB was knocking rates below zero in June 2014, she considered it “madness” and promptly cut her spending, set aside more money and bought gold. “I now need to save more than before to have enough to retire,” says Ms. Hofmann, 54 years old.
Recent economic data show consumers are saving more in Germany and Japan, and in Denmark, Switzerland and Sweden, three non-eurozone countries with negative rates, savings are at their highest since 1995, the year the Organization for Economic Cooperation and Development started collecting data on those countries. Companies in Europe, the Middle East, Africa and Japan also are holding on to more cash.
The article then discusses that these consumers all went on a saving binge..because demographics! because central banks did a bad job of PR! Only then does it turn to the idea that the higher savings rates were caused by negative interest rates.
How could they have believed otherwise? Do these economists all have such fat pensions that they have no idea what savings are for, or alternatively, they have their wives handle money?
People save for emergencies and retirement. Economists, who are great proponents of using central bank interest rate manipulation to create a wealth effect, fail to understand that super low rates diminish the wealth of ordinary savers. Few will react the way speculators do and go into risky assets to chase yield. They will stay put, lower their spending to try to compensate for their reduced interest income. Those who are still working will also try to increase their savings balances, since they know their assets will generate very little in the way of income in a zero/negative interest rate environment.
It is apparently difficult for most economists to grasp that negative interest rates reduce the value of those savings to savers by lowering the income on them. Savers are loss averse and thus are very reluctant to spend principal to compensate for reduced income. Given that central banks have driven policy interest rates into negative real interest rate terrain, this isn’t an illogical reading of their situation. Ed Kane has estimated that low interest rates were a $300 billion per year subsidy taken from consumers and given to financial firms in the form of reduces interest income. Since interest rates on the long end of the yield curve have fallen even further, Kane’s estimate is now probably too low.
Aside from the effect on savings (that economists expected negative interest rates to induce savers to dip into their capital to preserve their lifestyles and make up for lost interest income), a second reason negative interest rates hurt, or at least don’t help spending is by sending a deflationary signal. If things might be cheaper in a year, why buy now?
Some economists had nevertheless believed they could force consumers to spend in a negative rate regime by getting rid of physical cash. If citizens could not hoard cash, their monies would (presumably) be in bank accounts, where bank would charge them to hold funds, providing an incentive to go out and buy things. Note that negative interest rate fan Ken Rogoff has been a noisy advocate of getting rid of currency as important for this very reason.
Of course, the wee problem with that is banks don’t like charging consumer negative interest. They’ve kinda-sorta gotten there with fees, but a lot of countries make it hard to have a checking account relationship for less than $25 a month anyhow.
It is therefore particularly noteworthy that the Swedish central bank has deemed its negative interest rate experiment to be a flop since Sweden has one of the highest rates of digital currency use. From a September 2019 article:
Ask a Swede when they last paid for something in cash. The probable answer is last month or week….
Bengt Nilervall ot the Swedish Trade Federation explains why:
‘In terms of the cashless society, I think Sweden is ahead compared with other countries because in Sweden there is – in general – a trust in the government, the system, the banks and the authorities.’..
Every two years, Sweden’s central bank, Riksbanken, carries out a survey on payments patterns in Sweden. Between 2016 and 2018 card payments increased by 25 per cent, at the expense of cash payments.
Four out of five purchases in Sweden are made electronically, and Sweden’s central bank, Riksbanken, estimates that between 2012 and 2020, cash in circulation will have declined by 20–50 per cent.
In light of the above, the Financial Times article on the Swedish central bank raising rates to zero despite the economy being crappy is awfully muddled. It is hard to fathom if this results from the central bank sources trying to obfuscate for PR reasons or whether the arguments against a negative interest rate policy went over the reporter’s head and hence weren’t well represented in the story.
Sweden’s central bank ended its five-year experiment with negative rates amid growing concern about the implications for the economy, businesses and investors from sub-zero monetary policy….
The Riksbank on Thursday repeated its warning from October that if negative rates continued for too long “the behaviour of economic agents may change and negative effects may arise”.
The problem with the article is nowhere does it say why negative interest rates can be (ahem, are) counterproductive. Instead, the article dignifies critics who depict the Riksbank’s change as hawkish. Nowhere is there a peep as to the logic of the bank’s shift, save vague intimations of distortions. And nowhere is there a mention of more fiscal spending as a way to kick the economy out of the ditch.
Sadly, to paraphrase Max Planck, it appears that economics advances one death at a time.