Of all the unprecedented economic policy choices that have been made in the past 12 years, negative interest rates have the greatest Alice-in-Wonderland quality to them. Nominal rates below zero were a novelty in the history of finance — to the point where many eminent economists thought they were impossible.
Silvana Tenreyro, a member of the Bank of England’s monetary policy committee who thinks negative rates should be considered if circumstances were to call for more monetary stimulus, described such preconceptions in a recent speech:
“Generations of economists were taught in our textbooks that once policy rates fell to zero, interest-rate policy could no longer affect the economy. We have been conditioned to view zero as a hard constraint — the zero lower bound — on policy rates. Perhaps as a result, even though many central banks cut rates close to zero following the 2008-09 financial crisis, it was several years until any took them below zero.”
Even with a delay, only a handful actually went negative: Denmark, Sweden, Switzerland, the eurozone and Japan. Notably, the BoE and the US Federal Reserve have kept rates positive throughout, even as they have gone vanishingly close to zero.
It turns out it is hard to unlearn what has once been thoroughly learnt, even for (perhaps especially for) some of the world’s cleverest economies. When negative rates turned out to be possible after all, talk of the zero lower bound was replaced by simply “the lower bound” (or the “effective” lower bound), understood to be negative but close to zero. The presumed constraint is that at some point, people will hold money as cash rather than pay negative rates in the bank. Many economists think that even if you can cut policy rates below zero, it will no longer be effective in stimulating demand because banks will not pass the rate cuts on to the economy.
These are not idle beliefs; they have had real policy consequences. The thought that central banks were “out of ammunition” in terms of conventional rate cuts was at least partly why central banks did not try to cut more deeply (or not until later). Instead, they turned to unconventional policies, such as buying large amounts of bonds in “quantitative easing”, and many economists argued we should stop relying on monetary policy altogether. Everywhere, an aversion to (more) negative interest rates is on display, an aversion that for practical purposes has been absolute at the BoE and the Fed.
The problem is that the premise that rate cuts below zero cannot add further stimulus has turned out to be wrong.
When I caught up with Tenreyro to hear her case for not excluding negative rates as a policy tool in the UK, she told me the evidence was now clear that interest rate cuts worked pretty much the same way below zero as above zero.
“This is what we learned from the European and other countries’ experience” with negative rates, she said. “They have been equally if not more effective on the financial channel side of the monetary policy transmission” — their effect on market interest rates — “and slightly less effective on the lending channel”— the effect on banks’ lending terms. “But the latter is a smaller part of the monetary policy transmission so, in all, I would say that they have been effective, they work very well, and we should expect them to work well if they are needed in [the UK].”
She is not alone in her judgment that negative rates work largely like rate-setting in positive territory. At the IMF, Luis Brandao-Marques, Gaston Gelos and their colleagues have reached similar conclusions. (The IMF hosted an online seminar where Gelos and Tenreyro exchanged findings.)
More than a decade on from the global financial crisis, however, the BoE has been sluggish at getting itself in a position to cut rates below zero (its policy rate is currently 0.1). Only this year will it have ensured that the UK banking system is prepared should the MPC want to implement negative rates. The Fed has not even gone that far.
It might look like Tenreyro and those colleagues and counterparts who want negative rates to be firmly put in the toolbox may have overcome the resistance too late for it to be of any use. At the moment, it looks like the next move of most central banks will be to tighten rather than loosen. Covid-19 vaccine rollouts are progressing, an end to restrictions is becoming conceivable and the IMF has just joined the ranks of economists forecasting a global boom this year and continued strong growth in 2022.
But if things disappoint, there could be a need for renewed stimulus. As I have written elsewhere, the moment of maximum danger could be the end of restrictions and the associated withdrawal of financial support for individuals and businesses. When I asked Tenreyro what sort of scenarios could make renewed monetary stimulus appropriate, she mentioned a worsening of the pandemic through new vaccine-resistant variants and the possibility that consumers choose not to spend much of their accumulated savings. She also pointed out that monetary policy would be calibrated in light of what fiscal policy turns out to be. Faster fiscal consolidation, in other words, could increase the need for greater monetary support of demand.
Besides, the long downward trend in market interest rates means negative central bank rates will eventually be back on the table in the next economic cycle. It matters, then, that their suitability as a monetary policy tool has, if anything, been strengthened by the pandemic.
“Things have changed a lot,” Tenreyro told me. “The lower bound is not an immutable number. How far we can go depends on technological progress and also policy decisions. The lower bound today is much lower than 10 years ago and even last year” because of the pandemic.
“Today much more of our purchases and transactions are made online. Imagine if people, instead of digital payments, relied exclusively on cash. Every time they made an online purchase they would need to go to the post office or a bank to send money to their various suppliers. The cost of that time and inconvenience is significant and vastly outweighs the cost of small negative rates.”
She uses the example of someone with a typical balance of £2,000 in their deposit account; a negative 0.1 per cent rate would mean an interest cost of £2 a year. “Would she rather not pay that and go to the post office every time?”
The answer is obvious, and invites us to consider how much deeper rates could go and still be outweighed by the inconvenience factor — which “adds a lot to the cost of cash use today, on top of storage and safety issues”, Tenreyro said. “We live in a very different economy today where rates easily could go down without a massive switch to cash, which is the main reason why the lending channel may be less effective. The lower the lower bound is, the more effective the lending channel will be.”
And then there are policies available that could increase the cost of holding cash even further — fees on withdrawals, say. As Tenreyro pointed out, “economists have been discussing this for a century”. John Maynard Keynes himself devoted a section of the General Theory to Silvio Gesell’s early-20th century proposal for “stamped” money that would incur a charge for the holder.
If the lower bound is itself a function of policy choices, it can hardly be used as an argument against negative rates as a policy option. Making an assumption without any interest in probing its truth is dogma; clinging to it against emerging evidence to the contrary is superstition. Opposition to negative rates smacks increasingly of both — but, as all superstition, it is likely to evaporate eventually.
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