Would you be willing to pay your bank for holding deposits? The most likely answer is no. A large number of people may, in fact, prefer withdrawing money and keeping it at home, as return on cash cannot go below zero. This might be unimaginable in India, but some countries in the developed world may be inching close to this situation.
The European Central Bank (ECB) and central banks in countries like Switzerland, Denmark and Sweden have imposed negative interest rates on banks. Recently, the Bank of Japan (BoJ) also pushed the policy rate into negative territory. Although banks are hesitant to charge depositors as of now, they may be forced to do this if central banks push rates deep into the negative territory.
However, reasons for pushing rates into the negative are not the same for all. While the ECB and the BoJ are trying to stoke inflation and have taken this step after quantitative easing failed to produce the desired results, the Swiss National Bank adopted negative rates to discourage capital inflows. In fact, one of the biggest reasons behind negative rates is to encourage capital outflow, which will result in currency depreciation. A weaker currency will encourage exports and will also help import some inflation, or so the thinking goes. But all countries cannot export their way out at the same time by depreciating the currency. A stronger dollar, on the other side, is becoming a drag on the US economy and many argue that the Federal Reserve might have raised interest rates too soon. There will be pressure on the Fed if the other large central banks decide to push interest rates deep into the negative zone.
Although negative interest rates may look like an act of desperation on the part of central banks, the idea is not entirely new. Silvio Gesell (1862-1930), a German economist, argued in favour of carrying cost on money. He also proposed the idea of stamped money, where currency notes will lose value if they are not stamped each month with a stamp purchased from the post office—cost on hoarding cash. Gesell’s recommendations were acknowledged by John Maynard Keynes in his celebrated work The General Theory of Employment, Interest and Money. “…he (Gesell) had carried his theory far enough to lead him to a practical recommendation, which may carry with it the essence of what is needed, though it is not feasible in the form in which he proposed it,” Keynes noted.
Will negative interest rates work in the present macroeconomic conditions? Central banks are clearly in uncharted territory where gains from negative rates are somewhat uncertain and risks are more profound. Deeper negative rates will affect profitability in the banking sector and can impact financial intermediation. Imposition of negative rates on bank accounts may encourage use of cash, which will make negative rates ineffective to an extent, and could be a risk for financial stability. It will also affect numerous existing contracts with floating interest rates. For example, lenders may prefer walking out of contracts rather than accepting negative nominal returns. So, there are limits to which negative rates can be used and the aim of pushing prices remains uncertain.
Adair Turner of the Institute for New Economic Thinking in a recent paper highlighted the idea of “monetary finance” as a policy option in the present condition. Monetary finance essentially means financing fiscal deficits by increasing the monetary base (see The Case for Monetary Finance—An Essentially Political Issue). One way of doing this is that the central bank credits the government’s account and records it as non-redeemable and non-interest bearing receivable. The government can then spend the money without worrying about repayment which will help economic activity. But this option will always be prone to the risk of excessive use, as also noted in the paper, which can have other damaging consequences.
Clearly, central banks in some of the advanced economies seem to be running out of options and unorthodox policy experiments might end up creating more complications for the global economy.
Perhaps it is time to accept that problems in these economies are no longer monetary in nature.
Will negative interest rates help stimulate price and economic activity?
