In recent weeks the Bank of England has given the impression
that it may be prepared to take interest rates into negative territory.
Although the debate has gone a bit quiet of late, it has not gone away, perhaps
because the BoE believes the economic collapse in April was not quite as bad as
previously expected or, and this is my preferred take, it was only ever a
device to jawbone market interest rates as low as possible.
The economist Silvio Gesell was one of the first proponents of negative interest rates in the nineteenth
century when he proposed a tax to dissuade people from hoarding cash. But it was
never seriously tried in a policy context until the Swiss introduced a policy
of negative rates in the 1970s in a bid to prevent foreign investment flows
from driving the franc higher. However the policy was deemed a failure and the
idea was eventually abandoned in 1978 after an experiment lasting six years. In
the wake of the 2008 financial crisis the idea came back onto the agenda with
Denmark being the first mover, again as a means to hold the currency stable.
This time, other countries followed suit with the likes of Switzerland (again),
the euro zone, Sweden and Japan all driving rates into negative territory. Both
the US and UK have resisted the charms of negative rates, largely because there
is a presumption in the Anglo Saxon world that the monetary transmission
mechanism ceases to operate properly with interest rates below the lower bound.
There are many good arguments
against negative rates
In the current policy
framework, the banking sector is charged a negative interest rate on its cash
deposits at the central bank. Banks have an incentive to run down their cash
holdings and either lend more into the wider economy or pass on the negative
cost to their customers who run down their money holdings, and in the process
stimulate the economy as they spend their cash. However, low interest rates and
flat yield curves distort time preferences for households and companies, which
results in sub-optimal resource allocation (e.g. they allow zombie companies to
operate which would otherwise cease trading). Central bankers who have observed
the experience of Japan over the last two decades cannot be blamed for calling
into question the usefulness of ultra-lax monetary policy. Ironically, in the
late-1990s I remember half-jokingly suggesting to a Japanese economist that the
BoJ should consider negative rates. It was probably not my greatest idea in
retrospect.
Furthermore, ultra-loose monetary policy distorts markets. By
reducing the returns to cash holdings, investors have an incentive to seek
higher returns by loading up on risky assets, which in turn results in widening
disparities between market prices and fundamentally justified levels. No
investor would question the view that low rates have helped markets to blow
out.
For all that, there is no good reason in theory why interest
rates should not go negative. After all
ancient mathematicians regarded negative numbers as “false” and it was not
until the late seventeenth century that respectable mathematicians such as
Leibniz began to take them seriously in Europe. Today, however, we are all
familiar with the concept and we might wonder why they were ever regarded with
such suspicion. Moreover to the extent
that real economic quantities respond to real interest rates, we have long
become used to the notion of negative real rates with nominal interest rates
lower than inflation.
Yet there is something of the taboo about a negative nominal
interest rate. Perhaps one reason is that the interest rate represents the cost
of time: it represents the return derived from waiting; from saving rather than
consuming. Perhaps it offends the Puritan streak in the western psyche. Or
maybe because the arrow of time only runs in one direction, a negative interest
rate somehow inverts the cost of time and is therefore perceived as unnatural.
Whatever the reason, many people have difficulties with the concept of negative
central bank rates.
For all the evidence amassed by the likes of the ECB
suggesting that negative rates have helped to stimulate the economy, we should
treat the arguments with a pinch of salt. Without any doubt, negative interest
rates penalise savers. Unless we are forced to work long past our planned
retirement date, we all need to make provision for old age and this is made all
the harder by low or negative interest rates. There may be an argument in
favour of temporarily trying to boost the economy by cutting rates into
negative territory but the ECB has held the depo rate below zero for six years.
I fear that a prolonged period of negative rates will ultimately prove
counterproductive as individuals attempt to raise their precautionary saving.
But consider this …
One of the key features of all the countries that have
experimented with negative rates so far is that they run a current account
surplus i.e. there is a surplus of domestic saving with respect to investment
(chart). Both the UK and US run current account deficits – they suffer from
deficient domestic saving. At first glance, you may ask whether negative rates in
these economies are such a good idea if they encourage further dissaving. In a
static framework, they are not. But let’s try to think through the dynamics.
Encouraging households to bring forward spending should widen the current
account deficit in the near-term and ought, in theory, to result in currency
depreciation. This in turn should generate higher imported inflation, which
after all is how central banks have justified their actions, and allow them to
respond by returning interest rates towards positive territory.
In this framework the key transmission mechanism is the
exchange rate. If the cut in interest rates is not sufficient to produce concern
in the FX market, the negative interest rate policy will not have the desired
effect. This might be because the pickup in consumption is insufficient to
generate a current account deficit so the currency market remains unconcerned.
Or it might be due to the fact that the currency in question (the likes of the
Swiss franc, yen and euro) acts as a safe haven, particularly since rates
elsewhere are also extremely low. In either of these cases, perhaps interest
rates will have to be pushed so far into negative territory to have the desired
effect that the side effects would be unacceptable. But this begs the question
whether they would work better in an economy which already runs a current
account deficit, and where the FX market is perhaps more sensitive to external deficit
concerns. The pound would certainly be such a candidate.
I would be hesitant to advocate the BoE cutting interest
rates into negative territory because the experience elsewhere shows that once
they go below the zero line, it proves difficult to get them back up again. But
if I were a maverick on the MPC I would at least try to ensure that this
argument gets a hearing and make the case for a short, sharp dip into negative
territory with the unspoken assumption that they will be raised after (say) two
years. There is nothing to be gained by holding rates below zero for long. But
there also seems little to be gained from a prolonged period of holding them so
close to zero they might as well be negative.
No comments:
Post a Comment