Let’s welcome negative interest into our lives!

Blogs Economy

  • In the past, central banks have often dropped rates by six percentage points or more to bring about recoveries. The only way to achieve a similar effect in today’s low-rate environment would be to take rates strongly negative.

  • It is time for central banks and governments to give the idea a long, hard, and urgent look. However, we do need to remember: A lower interest rate doesn’t make a debt go away.

By Nazarul Islam

A debilitating virus has generated enough shock waves to move the tectonic plates of our global economy. Some changes were drastic and long-term. It has been hard to imagine that a person could be paid to borrow money, or be penalized for saving it. The extreme economic shock waves from Corona virus have obviously called for extraordinary responses.

President Donald Trump had been advocating for negative interest rates well before the ongoing pandemic, the economy to a standstill, arguing that erasing borrowing costs would spur economic growth.

“Negative interest rates sound like fun but it’s nothing to wish for,” McBride of the Federal US Reserve, was quoted saying at a seminar. “It hasn’t even proven to be effective,” he added. “Parts of Europe have had negative interest rates for seven years and it hasn’t done anything — their economies were reeling then, they’re reeling now.”

For everyday Americans, negative interest rates would likely result in even lower mortgage rates and credit card rates, but “nobody is going to pay you to take out a loan,” McBride said. “Sorry.”

In fact, with so many people under severe financial strain, it’s getting harder and harder to borrow at all.

Mr. Greenspan, the Chief of Federal US Reserves performed excellently in the early 1990’s. But recently he had fallen prey to the theory that prosperity causes inflation. So they’re trying to slow the economy down by raising interest rates. It’s like a doctor saying you’re in great health, so we have to make you sick a little bit. It’s a bizarre theory. It’s going to hurt economy.

Despite already rock-bottom interest rates, banks in the US are tightening lending standards across the board, shrinking the availability of credit.

It’s more likely that savers will lose any benefit to stashing cash, said Meenaz Sunderji, an executive vice president at banking software firm Zafin.

For those who viewed negative interest rates as a bridge too far for central banks, it might be time to think again. Right now, in the United States, the Federal Reserve —supported both, implicitly and explicitly by the Treasury—is on track to backstop virtually every private, state, and city credit in the economy. Many other governments have felt compelled to take similar steps. A once-in-a-century (we hope) crisis calls for massive government intervention, but does that have to mean dispensing with market-based allocation mechanisms?

Blanket debt guarantees are a great device if one believes that recent market stress was just a short-term liquidity crunch, soon to be alleviated by a strong sustained post-COVID-19 recovery. But what if the rapid recovery fails to materialize? What if, as one suspects, it takes years for the US and global economy to claw back to 2019 levels? If so, there is little hope that all businesses will remain viable, or that every state and local government will remain solvent.

A better bet is that nothing will be the same. Wealth will be destroyed on a catastrophic scale, and policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit, a process that will play out over years of negotiation and litigation. For bankruptcy lawyers and lobbyists, it will be a bonanza, part of which will come from pressing taxpayers to honor bailout guarantees. Such a scenario would obviously be an unholy mess.

Now imagine that rather than shoring up markets solely via guarantees, the American Fed could push most short-term interest rates across the economy to near or below zero. Europe and Japan already have tiptoed into negative rate territory. Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to say, negative 3% or lower.

A system of capitalism has presumed sound money, not fiat money manipulated by a central bank. Capitalism cherishes voluntary contracts and interest rates that are determined by savings, not credit creation by a central bank.

For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this—negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. So, before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?

A number of important steps are required to make deep negative rates feasible and effective. The most important, which no central bank (including the ECB) has yet taken, is to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies. Various combinations of regulation, a time-varying fee for large-scale re-deposits of cash at the central bank, and phasing out large-denomination banknotes should do the trick.

It is not rocket science (or should I say virology?). With large-scale cash hoarding taken off the table, the issue of pass-through of negative rates to bank depositors – the most sensible concern – would be eliminated. Even without preventing wholesale hoarding (which is risky and expensive), European banks have increasingly been able to pass on negative rates to large depositors. And governments worldwide would not be giving up much by shielding small depositors entirely from negative interest rates. Again, given adequate time and planning, doing this is straightforward.

Negative interest rates have elicited a blizzard of objections from all corners of the globe. Most however are either fuzzy headed or easily addressed, present or future of currency. One should not think of “alternative monetary instruments” such as quantitative easing and helicopter money as forms of fiscal policy. While a fiscal response is necessary, monetary policy is also very much needed. Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates can do the job.

A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic.

Even with negative rates, many countries would still need a debt moratorium. But a weaker dollar, stronger global growth, and a reduction in capital flight would help, especially when it comes to the larger emerging markets.

Tragically, when the US Federal Reserve conducted its 2019 review of policy instruments, discussion of how to implement deep negative rates was effectively taken off the table, forcing the Fed’s hand in the pandemic. Influential bank lobbyists hate negative rates, even though they need not undermine bank profits if done correctly. The economics profession, mesmerized by interesting counter-intuitive results that arise in economies where there really is a zero bound on interest rates, must share some of the blame.

I also have reasons to believe that Emergency implementation of deeply negative interest rates would not solve all of today’s problems. But adopting such a policy would be a start. If, as seems increasingly likely, equilibrium real interest rates are set to be lower than ever over the next few years,

Defenders of NIRP (Negative Interest Rate Policy) insist the program simply needs time to take hold. The real problem, they maintain, is the timid way that subzero policies have been rolled out.

Central banks, all over, according to these proponents, should trumpet negative rates. Policy makers should vow – loudly and aggressively – to stick with NIRP until expectations have been reshaped and the economy is booming once again.

“Here’s the wrong way (for central banks) to communicate: Keep saying that negative is a purely emergency setting that will be abandoned shortly,” writes Narayana Kocherlakota, a former president of the Minneapolis Federal Reserve Bank who now teaches economics at the University of Rochester.

“Here’s the right way to communicate: Keep saying that all available tools, including negative interest rates, will be used as is needed to return employment and inflation to desirable levels as rapidly as possible.”

Later, on the pro side, Ian has also quoted Nick Rowe:

“There has never been anything wrong in theory with charging negative rates,” says Nick Rowe, a professor of economics at Carleton University and an authority on monetary policy.”

The objection was always this notion that people would just withdraw their money from the bank and go to cash, which pays zero interest but at least doesn’t impose a negative rate.

However, a rush to paper money hasn’t materialized in the countries that have imposed negative rates, perhaps because the rates have been only mildly negative.

Economists acknowledge that it’s administratively tricky to impose negative rates, but they don’t see the problems as insurmountable. Prof. Rowe has argued that the important factor for any lender is the spread between its deposit rates and its lending rates, not whether those rates happen to be negative or positive. I feel, it is relatively simple for a bank to adjust its business model to still make money with negative rates, agrees Miles Kimball.

A long-time advocate for negative rates, he argues that policy makers should be far more aggressive in pushing down lending costs.

He says banks should realize their real enemy is the current new normal of anemic growth. The failure of the global economy to revive after years of zero-rate therapy is conclusive evidence that stronger medicine is necessary, he argues. “If you don’t take the right dosage of a drug, it doesn’t work.”

Both Europe and Japan immediately need to push rates even lower, he says. While negative rates of, say, minus 2 per cent or even lower might shock observers at first, they would be in keeping with what history tells us is necessary.

In the past, central banks have often dropped rates by six percentage points or more to bring about recoveries. The only way to achieve a similar effect in today’s low-rate environment would be to take rates strongly negative.

Wouldn’t that unfairly punish ordinary mom-and-pop savers? Not at all, he says. “Savers would be far better off if we had brief periods of deep negative rates that would quickly restore growth, rather than long periods – like now – of near-zero rates, where nobody makes any real return for years.”

To be sure, not everyone might welcome the details of how Prof. Kimball plans to lower interest rates far below zero. To avoid the possibility that savers would flock to cash rather than take a beating on the “electronic” currency in their bank account, he would impose a discount on folding money.

“Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars,” he writes.

A situation where paper money might not be worth its face value would be disturbing for most people and it’s not the only disquieting aspect of a subzero strategy.

Prof. Kimball has acknowledged that there are big psychological barriers to negative rates, and suggests there would be ways to get around the worst side effects. Ideally, he says, negative rates would apply mostly to institutional and business accounts while leaving most ordinary savers and borrowers untouched.

“Our monetary system does change every 50 years or so, so change is possible,” he believes “People never thought we would go off the gold standard, but we did.” As disruptive as negative rates might seem, he had argued they are vital to restart growth. Most of Bay Street would bitterly disagree. Whichever side wins this argument is likely to shape the course of monetary policy for years to come.

It is time for central banks and governments to give the idea a long, hard, and urgent look. However, we do need to remember: A lower interest rate doesn’t make a debt go away.

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The Bengal-born writer is a senior educationist and settled in USA. He writes regularly for Sindh Courier, and the newspapers of Bangladesh, India and America. 

 

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