Your bank was paying you 2% interest on your deposit account and then reduces it to 0%. What do you do?
Obviously, it depends on your circumstances, but assuming you were not dependent on the income, you may come to the conclusion that whatever you were saving the money for (retirement?) now may not be covered by your savings plus interest. Understandably, if you had a bit extra in your pocket you may look to save more to ‘top-up’ your savings and compensate for the loss of income.
Now, evil Mr Banker goes even further and starts charging you 2% for the pleasure of having your money on deposit with them.
What do you do? Again, understandably, you may look to top-up if your income allowed. If, for instance, your disposable income happened to rise by 5% (helped by a lower oil price?), you may reasonably look to make up for the shortfall again by the 5%. Alternatively, you may even look to cut back on spending to fund the top-up.
You are a central banker’s nightmare.
Many of developed nations’ central banks are in the process of lowering interest rates from a zero interest rate policy (ZIRP) into negative interest rate policy (NIRP) territory and want consumers to go out and spend the money to boost demand growth, not save it. Of course, they want the commercial banks to do this first by charging them for depositing money at the central bank, thereby encouraging them to use this money to lend to borrowers to raise economic growth.
But, is this inducement to more debt a good basis for future growth? Yes, some companies need growth capital but many are now simply using this cheap funding to buy back shares – hardly productive use of capital.
Good for Nothing
So, who gains from the negative rates?
Not the commercial banks. They rely on lending long-dated (mortgage) debt and funding that with short-term credit but when the two are roughly the same (called a flat yield curve) then they start to hurt.
Not the consumer. Banks are not going to pay us to take out a mortgage and so the average retail lender is always going to be paying positive interest rates. Not only this, but savers will start to feel the pinch as depositing and saving institutions will start to pass on the costs of deposits to consumers.
Not companies. Like retail customers, companies are always going to be charged for the risk of default and whilst this process may lower the cost of borrowing, almost no companies will be able to issue debt at negative rates – in fact the concerns over the consequences of NIRP have raised the costs of commercial credit over recent weeks.
Central banks? Ah-ha. Many central bank mandates are set out in terms of inflation targets – both the Bank of Japan and the Bank of England, for instance, have a single mandate of 2% inflation. If inflation is below that target, you cut rates and if this persists you cut them some more. Simple.
Adding this simplistic approach to monetary policy to the heavy-weight buying of bonds through quantitative easing programmes has driven bond yields to below zero where any holder to maturity is guaranteed a loss. There is now around $8 trillion of government debt trading at a negative yield.
However, this narrow and myopic monetary approach to economic stimulus has clearly had unintended consequences.
Asset markets have given their vote and they do not like it at all. NIRP is seen to weaken the bank model and raise the prospect of defaults of non-bank financial institutions such as building societies and pension companies. A faltering banking system is no basis for an economic recovery.
NIRP used to seen as part of the process to weaken the currency which would thereby lift the overseas earnings of exporters but the recent move to NIRP by the Bank of Japan has proven the opposite can be true.
The investment bank JP Morgan has recently written that European rates could go as low as -4.5%, Japan could go to -3.5%, the US Federal Reserve could go to -1.3% and the Bank of England could reduce short term interest rates to as low as -2.7%.
Central banks have created this chthonic force which is spreading rapidly and threatens the very purpose of a central bank which is economic stability and growth.
Plan B, please
Maybe it is time to change the music. Move to Plan B. Sure, the central bank mandates could be re-written to equally focus on growth but maybe we need to bring on the fiscal policy guns too.
We are no fans of Big Government but additional spending on the aging and creaking infrastructure of a country has been a tried and tested way of boosting an economy through times of weak growth. We don’t mean roads to nowhere – properly thought out large-scale projects to improve social conditions such as affordable housing and improving efficiencies in transportation and electricity generation can lead to economic growth. Such projects should include schemes to tackle climate change too, from proactive investment in areas that reduce energy usage (e.g. insulation) and reduce carbon emissions, to preventative measures to reduce the consequences of climate change such as flood prevention.
Obviously, this expenditure needs funding. However, thanks to the negative interest rate policy of many central banks, institutions are willing to pay governments for the debt that they issue. Such are the perverse consequences of negative interest rates – now is the time to use them for benefit of all?
The information provided through the Equilibrium website is based on our opinion and is for general information purposes only. It is not, and should not be construed as financial advice.