Don’t expect too much if we get negative interest rates

Are central bankers jealous that epidemiologists are the rock stars of the current crisis?

There is talk that both the British and New Zealand central banks might institute negative interest rates as part of the policy response to the Covid shock. 

While Sweden’s central bank ended its five year experiment with a negative policy rate in February, just before the Covid crisis kicked off, negative rates have been in force in Japan, the Eurozone and Switzerland for some years now.

But before getting too excited, it’s unlikely you will get paid to take out a mortgage (which happened briefly in Denmark).  It’s more likely that you’ll get less interest on your savings account.

Nor should a ‘negative interest rate policy’ be regarded as a financial Rubicon.  Thanks in part to high savings from politically unstable countries and high demand for liquidity in rich ones, we already live in something of a zero-to-negative interest rate world, with $15 trillion-worth of negative yielding financial securities globally circulating.

What is normally meant by a negative interest rate policy is the central bank charging commercial banks to deposit their surplus funds with it.  This is supposed to encourage them to lend even more to customers at cheaper rates than they would otherwise have offered.

The theoretical argument is that where the economy is at risk of recession and falling prices, you may find yourself in a situation where you ought to pay people to borrow for investment or spending in order to reach an equilibrium.

But use of negative interest rates today doesn’t entirely fit this textbook definition.  Because commercial banks (and their saver customers) have limited options for avoiding them, they look more like a quirk of the regulatory structure.

That makes them useful for achieving non-market outcomes – temporarily depressing returns to banks and savers, and interest rates for borrowers; and even directing cheaper credit to favoured sectors or granting exemptions to powerful interest groups.

They also act as a tax on banks, and risk storing up some problems in the banking sector that can be tricky to unwind.

Central banks already have a pretty impressive range of financial bazookas to get money out into the economy.  So if negative interest rates are being touted as the answer, you might ask yourself if the problem is something else.

The current problem is letting businesses and workers adjust to the economic shock of Covid.  Monetary – and indeed fiscal – policy can cushion the adjustment process.  Or it can be used to avoid it – for a while.

And if you worry that the problems for policy makers are difficult now, look back to the 1970s and 1980s, a period in which there was an abrupt shift to high nominal and real interest rates.  Markets (read the public) lost confidence in governments’ ability to direct the economy and governments relinquished control of their ability to direct capital.  It took a while to happen, and longer to fix.

Thankfully the macro factors supporting the current low level of interest rates seem well entrenched.  Which encourages confidence that governments and central banks are well in control.

But do bear in mind that what can’t last for ever, generally doesn’t.  And when things change, they can change fast.

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