Negative Interest Rates Are Not the Drama They Seem
Ah, for the good old days of quantitative easing when central bankers agreed what needed to be done to spur economic growth. No longer. In Tokyo, Haruhiko Kuroda, Bank of Japan governor, has just reiterated that he will not rule out a “deepening cut” to the country’s negative interest rates.
In contrast, Mark Carney, Bank of England governor, has announced he is “not a fan of negative rates” and Thomas Jordan, president of the Swiss National Bank, has reaffirmed his belief that its “current approach,” including negative rates, “is the right one.”
Meanwhile, Janet Yellen, chair of the US Federal Reserve, told Congress in May that “while [she] would not completely rule out the use of negative interest rates,” they would be a last resort.
This is too much fuss over just another policy instrument. The drama and division among central bankers reflect two intellectual errors that have distorted monetary policy discussions. These are the same mistakes that led to the demonization of quantitative easing as “unconventional” and thus dangerous, when in fact it worked pretty much as expected in reducing interest-rate spreads, encouraging riskier asset purchases and adjusting the currency. Negative rates will prove less universally applicable but have also proved predictable and useful in impact.
The drama and division among central bankers reflect two intellectual errors that have distorted monetary policy discussions.
The first error is believing that the majority of financial decisions will respond significantly to any shifts in government borrowing costs. In precrisis days, policymakers assumed that tweaking short-term interest rates was enough to influence all important financial decision making. This was wishful thinking, based on a couple of decades of atypical US experience. Other economies still needed extra policy instruments, as has the United States since the crisis. The absence of stable relationships between credit growth and interest rates, as well as the history of central banking, should have told policymakers and investors that government bond markets were not the only game in town.
Sadly, any regard for such structural differences remains absent from the hyped concerns over negative rates. Also a simple reality is being ignored. Economies such as Germany and Italy, where a large share of savers hold their assets in simple bank deposits and much of the corporate sector receives its financing from bank loans, will benefit less from negative rates. If anything they will suffer the direct costs. By contrast, in economies such as the United States and Australia, where savers and companies are more flexibly financed, borrowers will move out of banks and into other forms of saving and financing.
The second error is to ignore the political context. Where there are institutions, there are political interests. The discussion of negative rates does not take these into account. Of course, official statements are constrained in how much they can acknowledge politics. Yet such omission limits discussion and leads to mistaken policy design.
Where a cabal of banks and officials works to tie up savings in the traditional banking system and savers depend upon that arrangement, the political reaction against negative rates will be greater. Where savers have more options they tend to have more diversified assets, and so will be less resistant to negative rates. The same is true for economies where business has greater choice and is less bank dependent.
If monetary policy reacts to such issues, it will reflect political pressures, giving way to measures to protect banks and savers from negative rates. But if central banks protect savers from the impact of the negative rate, they have no incentive to move funds and the overall impact of the policy will be minimal.
The same analytic errors also lead central banks to ignore the importance of capital mobility to the effectiveness of negative rates. On paper, all the major economies except China have open capital accounts. The degree of capital market integration, however, varies greatly even among the richest economies: Savers in Japan are far less likely than their Swiss counterparts to move their assets abroad. While large multinationals raise funds globally in both countries, the exposure to international capital for the rest of Swiss business is much higher than for Japanese companies, and their adaptability is greater. Politics has developed to reinforce these patterns: Swiss citizens and businesses recognize that they cannot escape global spillovers; their Japanese counterparts expect their government to shield them.
So it should surprise no one that Switzerland has had more political room to pursue negative rates than Japan. One should expect a similar response in Germany or Italy to that in Japan, as the European Central Bank has found. Where traditional banking and small business are politically dominant, financing and saving options tend to be more limited, and less subject to exit into global markets by dissatisfied savers. In such cases the exchange rate impact of negative rates is muted as well. As a result, it was predictable that in those economies negative interest rates are less effective.
Taking these oft-ignored factors into account, the Bank of England and even more so the Fed should be less hesitant. In the United States and the United Kingdom, households have more options and display more flexibility for their savings than in Japan or much of the eurozone. Negative rates are just another monetary policy tool, good for some situations and not for others, with no deep mystery or drama required.