Aug 30, 2019

Negative interest rates have hurt, not helped

Dion Rabouin, author of Markets

Illustration: Aïda Amer/Axios

The European Central Bank (ECB) is expected to push forward with deeper negative interest rates next month and the Fed looks to be considering implementing them in the U.S. should the current economic slowdown accelerate.

The big picture: There's growing evidence that the experimental policy designed to increase spending, boost inflation and stimulate the economy has done more harm than good.

What they're saying: Recent research from the San Francisco Fed finds that after the Bank of Japan announced negative rates in 2016, "market expectations for inflation over the medium term fell immediately."

  • "The reaction stresses the uncertainty surrounding the effectiveness of negative policy rates as expansionary tools," especially when inflation is as stubbornly low as it is now, researchers Jens Christensen and Mark Spiegel write.

Research on Europe's experiment with negative yields has drawn similar conclusions.

  • A study from the University of Bath concludes that negative interest rates have weakened demand and decreased lending because the additional costs reduce banks’ profit margins.
  • “This is a good example of unintended consequences,” said Ru Xie, one of the study’s authors. “Negative interest rate policy has backfired, particularly in an environment where banks are already struggling with profitability.”

Even so, incoming ECB president Christine Lagarde insists the eurozone would be "worse off" without negative rates, and the Fed looks to be headed toward an embrace of negative rates as well.

  • Minutes from July's FOMC meeting mention “ELB" 15 times. (ELB is the effective lower bound, a reference to the lowest level interest rates can go.) That's up from 0 mentions in the June meeting’s minutes, notes Ed Yardeni, president and chief investment strategist of Yardeni Research.
  • "The presumption is that the federal funds rate can’t fall below zero," he says in a note to clients. "Yet the minutes hinted that Fed officials might be thinking that if they have to lower the federal funds rate to zero, it’s a slippery slope from there to considering going negative."

Watch this space: European bankers are increasingly worried about the harm negative rates are doing to the business of banking and are trying to pass the cost onto consumers.

  • If that happens, people may start stuffing cash in their mattresses, worries Jesper Berg, director general of the Financial Supervisory Authority in Denmark. That would likely put more pressure on banks and shrink the financial industry.
  • “If you continue to stay in this environment,” Berg told Bloomberg recently, "something needs to give."

Go deeper: Fed tweets show Trump doesn't understand central banking

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