Global era of negative interest rates ends
The world’s nearly 12-year experiment with negative interest rates is over now that the last holdout, the Bank of Japan, has moved its key policy rate back to at least zero. Of the many unusual measures central bankers took over the past decade and a half, negative rates were among the most controversial, with uncertain benefits and potential risks.
The experiment’s bottom line: Negative rates weren’t enough by themselves to pull economies out of a funk or lift inflation toward central banks’ 2% targets. It took the Covid-19 pandemic and war in Ukraine to accomplish that.
Yet if negative rates weren’t a cure-all, they seemed to help at least a little. In Japan’s case, negative rates, after a delay, contributed to driving the yen down and import prices up, fueling the return of inflation. Despite some adverse effects, banking systems didn’t totter as feared.
So while central bankers are retiring negative rates for now, they will almost certainly keep them in the toolbox in case a similar emergency recurs—perhaps as a threat that never has to be used. If market conditions demand it, “we always have that option of going back to minus,” said Yutaka Harada, a former Bank of Japan policy board member who backed negative rates.
Once no more than a theoretical curiosity, negative rates became thinkable after the global financial crisis of 2008 put many of the world’s advanced economies in a deep freeze sometimes called secular stagnation. Even after pushing interest rates down to zero, central banks struggled to generate what they viewed as a healthy level of inflation.
Regular depositors can preserve their cash by storing it under a mattress. But central bankers realized that their depositors—commercial banks—couldn’t easily find mattresses big enough to hide billions of euros or kroner safely. Those depositor banks could be made to pay interest instead of earning it.
In 2012, Denmark’s central bank imposed negative rates on deposits held by commercial banks, followed by the European Central Bank in 2014 and
the Bank of Japan in early 2016, as well as Sweden and Switzerland. In theory, according to the International Monetary Fund, a negative-rate policy “supports economic activity and inflation through the same channels as conventional interest rate cuts.” The policy pulls down interest rates across the board and makes it easier for businesses to borrow and spend. That should boost overall demand and trigger inflation.
Did the theory work in practice?
The effects, if any, weren’t obvious. Economies in Europe and Japan remained lackluster with below-target inflation even after negative rates.
“There are some studies that find, yes, there’s some additional credit extension. There are other studies that find there’s actually less,” said Hugo van Buggenum, a central-bank scholar at KOF Swiss Economic Institute in Zurich.
Izumi Devalier, an economist at Bank of America in Tokyo, said a slightly negative rate— minus 0.1% in Japan’s case— wasn’t different enough from zero to fundamentally change expectations in economies burdened by inadequate demand and pessimism. “The fiscal side is more important,” she said, pointing to big government spending programs in the early days of the pandemic that stimulated growth.
Last fall, van Buggenum co-wrote a Federal Reserve working paper suggesting that the theory behind negative rates was flawed. Because customs or regulations make it hard for commercial banks to charge negative interest on deposits, central banks’ negative rates undermine the banking system’s health, the authors found.
An unwelcome surprise was the way negative rates hit public psychology. In Japan, a plethora of headlines with the word “minus” left the impression people were about to take a hit to the wallet.
“The average person isn’t much interested in monetary policy. But when we had minus rates, suddenly daytime TV was getting odd ly excited and people were talking about how safes were selling. It wasn’t great,” recalled Harada, the former Bank of Japan board member. “Because the public was resisting it, an atmosphere developed in which financial institutions grew more confident about resisting .”
Still, the IMF concluded in 2021 that the negative-rate policy “has likely supported growth.” Some central bankers said that by showing there was no floor, negative rates were helpful in showing determination to stimulate the economy.
While the Federal Reserve never adopted negative rates, “the Fed should also consider maintaining constructive ambiguity about the future use” of the tactic, former Fed Chairman Ben Bernanke wrote in a 2020 blog post. Negative rates in Japan initially didn’t push down the yen because other central banks had zero or negative rates. But in 2022, the Fed started raising rates, and soon after, European central banks including the ECB ended their negative-rate policies.
The widening gap between those regions’ rates and Japan’s negative rate encouraged investors to move their money to dollars and euros, and the yen plunged to three-decade lows.
Japanese importers of food and fuel passed on the higher costs to consumers. Exporters such as Toyota brought in more yen from the dollars they made overseas, and their made-in-Japan products became more cost-competitive on global markets. This year, many companies in Japan are using their fat profits to give raises of more than 5% to workers. Inflation, pushed up by import prices, is running above 2%.
That was justification enough for the Bank of Japan to end its negative-interest-rate policy.
It might not be back for a while, at least in Europe and Japan. Among major economies, only China seems to display the potential signs of secular stagnation, such as a popped real-estate bubble and a chronic shortfall of demand.
But whenever stagnation returns, the lure of negative rates as a last-ditch tool will remain.