The future of negative rate policies
Meanwhile, the NIRPs resulted in a flight to cash.
Demand for cash grew for some countries as interest rates declined. For example, Switzerland saw its bank note circulation increase after the introduction of NIRP.
In Japan, cash holdings have also risen, but this trend was already in place before negative interest rates were introduced. In Sweden, the trend has been towards lower cash holdings despite declining interest rates – as more efficient, electronic transaction technology outweighed the lower opportunity costs of holding cash.
The NIRP has several setbacks. NIRPs can affect bank’s profitability, even when a flight to cash does not occur.
With the banks unable to pass on the negative rates to depositors, or if they cannot maintain bank lending rates at levels sufficient enough to safeguard a normal rate of profit, their ability to lend could decline. It can reduce banks’ lending and thus weigh on the economic growth while inflating the risk of deflation.
Also banks can get hurt by NIRP especially if their balance sheets are not too strong.
What could happen is that there will be a switching from riskier assets like loans into ‘safer’ assets such as bonds. When this takes place, it can exacerbate the credit crunch and economic downturn.
On the whole, is there a future for NIRPs?
From the looks of it, this policy has at least so far failed to exhibit different effects on the economy from what is expected during periods of conventional policy easing.
That could partly be because the negative rate and the breadth of the policies’ application has been limited so far.
If that is the case, do policymakers need to apply NIRP more robustly should another economic downturn set in, given the current strong uncertainties on the global front coming from European elections, US policies and the direction of the Chinese economy amongst others.
Or should they look for alternative policies?
Much will depend on whether other policy tools will be at the disposal of central banks and are they more effective?
Small economies trying to reduce pressure on their currencies may find negative rates easier to implement than letting their central bank balance sheets expand due to large purchases of foreign bonds.
On the other hand, larger economies – notably the eurozone and Japan – currently seem to be losing confidence in the effectiveness of negative rates in addressing the problems of slow economic growth and low inflation.
Anthony Dass is head of AmBank Research, AmBank Group