The new fron­tier of neg­a­tive in­ter­est rates

The Pak Banker - - OPINION - Clive Crook

WHEN cen­tral banks start ex­plor­ing strange new worlds, the re­sults aren't al­ways ideal. Quan­ti­ta­tive eas­ing wasn't just a change in mon­e­tary pol­icy, but a whole new kind of mon­e­tary pol­icy -- a jour­ney into the un­known. It isn't over yet, but there's al­ready a de­bate about draw­backs and un­in­tended con­se­quences. With that ques­tion far from re­solved, an­other ad­ven­ture in su­per-loose mon­e­tary pol­icy has be­gun: neg­a­tive in­ter­est rates. This week, as global mar­kets plunged, un­fore­seen com­pli­ca­tions have arisen there too.

Shares in Euro­pean banks suf­fered es­pe­cially badly dur­ing this re­newed mar­ket tur­moil. There was more than one rea­son, but neg­a­tive rates seem to be im­pli­cated. Banks' de­posits at the Euro­pean Cen­tral Bank now pay mi­nus 0.3 per­cent, and a fur­ther cut has been ad­ver­tised for next month. The idea is to en­cour­age banks to lend more (rather than sit on idle bal­ances) and to lower the cost of cap­i­tal for riskier bor­row­ers. The new con­cern is that neg­a­tive rates have and put their sound­ness in ques­tion.

Ad­vo­cates of neg­a­tive rates might be per­plexed by this ap­par­ent squeeze on bank prof­its. They might won­der, why should that hap­pen? Banks sim­ply have to pass the neg­a­tive rate on to their var­i­ous cus­tomers, bor­row­ers on one side and lenders on the other. The spread be­tween the two needn't change. But it seems that banks have been re­luc­tant to force neg­a­tive rates on to their de­pos­i­tors -- hence the squeeze on prof­its. Per­haps the banks are wor­ried that de­pos­i­tors wouldn't like it. Up­set­ting them is some­thing banks are un­der­stand­ably re­luc­tant to do.

Pol­icy mak­ers seem to have doubts as well. The Bank of Ja­pan re­cently star­tled fi­nan­cial mar­kets by adopt­ing neg­a­tive rates, hav­ing pre­vi­ously said it wasn't go­ing to -- but it struc­tured the new pol­icy so that it works at the mar­gin of the banks' bal­ances with the cen­tral bank, rather than ap­ply­ing to the to­tal. Why? So that the banks wouldn't need to pass the change through to de­pos­i­tors. Pol­icy mak­ers and banks alike are em­brac­ing neg­a­tive rates timidly -and they're right to be cau­tious. Sub­stan­tially neg­a­tive rates would be an even braver ad­ven­ture than QE.

As I've pre­vi­ously men­tioned, a world of neg­a­tive rates is a very weird place -- one where savers pay bor­row­ers for the priv­i­lege of de­fer­ring con­sump­tion, and bor­row­ers get com­pen­sated for bring­ing spend­ing for­ward. An edi­to­rial in The Econ­o­mist made the point well: Small savers would use any avail­able form of pre­pay­ment-gift vouch­ers, long-term sub­scrip­tions, ur­ban-trans­port cards or mo­bile- phone SIM cards-to avoid the cost of hav­ing money in the bank.

That would be only the start of the topsy-turvi­ness. Were in­ter­est rates neg­a­tive enough for long enough, spe­cial­ist se­cu­rity firms would emerge that would build vaults to store cash on be­half of big de­pos­i­tors and clear trans­fers be­tween their cus­tomers' ac­counts. Firms would seek to make pay­ments quickly and re­ceive them slowly. Tax of­fices would dis­cour­age prompt set­tle­ment or over­pay­ment of ac­counts: one Swiss can­ton has al­ready stopped dis­counts for early tax pay­ment and said it wants to re­ceive money as late as pos­si­ble.

Well, that last part sounds quite ap­peal­ing. (Ev­ery­body's fa­vorite New Yorker car­toon comes to mind: "How about never? Is never good for you?") Peo­ple would ad­just to the new rules, even­tu­ally. Trou­ble is, that calls into ques­tion the pol­icy's usual ra­tio­nale: It's typ­i­cally seen as a tem­po­rary ex­pe­di­ent.

Con­cern­ing the flight to cash, that could be dealt with as well. To re­mind, with neg­a­tive rates in place, cash is a bet­ter place for sav­ings than a bank ac­count. The pos­si­bil­ity that peo­ple might switch to cash there­fore makes it dif­fi­cult to force rates below zero. The cost of hold­ing cash (in­clud­ing the risk that it might be stolen) creates some room for ma­neu­ver. Be­yond this, cen­tral banks could fur­ther dis­cour­age the use of cash by forc­ing down its value rel­a­tive to elec­tronic bal­ances -- in ef­fect, tax­ing its use -- or move to abol­ish it al­to­gether.

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