Why negative interest rates are justified.

The Free Exchange column in The Economist referred to negative interest rates as neither unfair of unnatural. Irving Fischer used the metaphor of the world’s oldest ship’s biscuits from a voyage back in 1852. Known as hardtack these biscuits were renowned for their longer storage life and therefore making them an important source of nutrition for sailors.

Fischer wrote in ‘The Theory of Interest’ in 1930 an imaginary scenario where a group of sailors are shipwrecked and the only food they have to sustain them is hardtack. Fischer proposed the question ‘under what circumstances would sailors borrow and lend biscuits? For most people interest is the reward for saving and delayed satisfaction so negative interest rates would seem to be unjust. In the case of shipwrecked sailors if one of them is prepared to lend another a biscuit the lender would want more than one biscuit in return and the more hungry they are the higher the interest rate. However Fischer pointed out that the interest rate should be zero as if it were positive it would mean that the sailor would have to take more than one hardtack biscuit to repay the loan. However no sailor would accept these terms as he could instead eat one more piece from his own supply, thereby reducing his future consumption by one hardtack biscuit. And a sailor who had already depleted his supply would be in no position to repay borrowed biscuits. If for instance the sailors were washed ashore with perishable items the interest rate would be negative – Fischer concludes that the rate of interest for any commodity should be negative not positive.

Recently banks in Japan, Switzerland, Denmark and Sweden started charging customers for saving money which asks the question why should people pay to keep their money in banks when they had already earned it? But charging customers interest is a natural occurrence when you consider that savers preserve their purchasing power without any care required to prevent any resources eroding. In 1916 economist Silvio Gesell gave his treatise in favour of negative interest rates on money. His said that storing wealth required considerable effort and ingenuity especially commodities like meat, wheat, fruit etc which are perishable. Gesell said that our goods rot, decay, break and rust. Only if money depreciated at a similar pace would people be as anxious to spend it as suppliers were to sell their perishable commodities. To keep the economy going he wanted money to rot like potatoes and rust like iron.

The negative interest rate introduced by Japan accompanied by an inflation target three years before is in effect pursuing Gesell’s dream of a currency that rots and rusts, albeit by only 2% a year.

Source: The Economist – Free Exchange – 3rd February 2018

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