Negative Interest Rates – will they really work?

Central bankers around the world have been toying with the idea of going into negative territory with interest rates. The economic indicators influencing their decision tend to focus on the inflation rate and the amount of spare capacity – output gaps. Some research has suggested that interest rates needed to go as low as -6.5% (UK in 2013) and -3% ( USA in 2014) to stimulate growth.

Negative interest rates does encourage people to take money out of their bank accounts and store in safe deposit boxes or under the mattress, the latter being vulnerable to theft. This makes the process of buying goods/services difficult – do you carry a lot of cash as electronic transfer is no longer used? Additionally online transactions would disappear with people holding cash. According to The Economist central bankers face three important questions.

  • The technical feasibility – rates could be pushed lower by getting rid of high-denomination banknotes and impose fees on large transfers might raise the cost of hoarding cash by enough to allow rates to be cut further.
  • Hurting growth – negative interest rates can weaken demand rather than boosting it. As commercial banks have to keep reserves at the central bank negative interest rates means that they are losing money. However the commercial banks may not want to pass these costs onto customers so their profits are squeezed. This is especially a concern for less profitable banks that may limit their lending and ultimately investment and growth.
  • Is it worth it? Is the easing of interest rates into negative territory enough to make the difference between a strong recovery or a weak one. Also will people still borrow when rates are negative. Even with the low rates today borrowing levels are not significant and even if rates went negative would it make any difference? Consumers are worried about taking on debt with job security a concern therefore borrowing is not a top priority.

In order to kick start the economy there needs to be more fiscal expansion. Giving people money with a wage subsidy or just crediting their bank accounts would be more effective in achieving more economic activity.

Source: The Economist – Should the Fed cut rates below zero? 23rd May 2020

Leave a Reply

Your email address will not be published. Required fields are marked *