The US should “accept the ‘GIFT’” of negative interest rates, US president Donald Trump tweeted last week; the former property mogul has long been an advocate of the benefits of cheap money. Negative rates are an indicator of deep economic troubles, and bring harmful side effects for pension funds and other investors, banks and insurers. Cutting policy rates below zero should remain, in extremis, part of the central bank toolkit. But a move into negative territory should not be cheered.
After negative interest rates were introduced by the European Central Bank in 2014 and in Japan in 2016, investors in interest rate futures are now starting to price in the possibility of negative rates arriving in the US and UK too. Such market moves should be treated with caution. The drop below zero in the US federal futures market probably has as much to do with banks managing their exposure to the derivative contracts taken out by corporate clients as with protection against interest rate volatility.
In the UK, by contrast, policymakers have said they are keeping the option on the table. On Wednesday, Britain’s government sold negative yielding bonds for the first time after publication of low inflation figures, and the governor of the Bank of England told a committee of MPs that negative interest rates were “under active review in the current situation”. A potential breakdown in trade talks with the EU is also weighing on investors’ minds.
US and UK central banks enjoy the advantage of seeing how the experiment has played out elsewhere. After six years, the European experience suggests negative rate doom-mongers have been wrong. Critics flagged up the possibility of a “reversal rate”, below which lower interest rates stop stimulating the economy and start acting as a drag. Central bankers in Sweden, which first introduced negative interest rates in 2009 and then again for nearly five years from 2015, have acknowledged they might cause long-term problems. Critics say they make it unprofitable for banks to lend and encourage savers to hoard cash. Sales of safes rocketed in Germany after the policy was introduced.
After the ECB brought in negative rates, however, bank lending resumed, helping to drive unemployment down and lifting the eurozone out of a potential deflationary spiral. Nor was there a widespread shift towards cash, which, given the cost of storing it safely, comes with its own “negative interest rate”. According to ECB research published last week, bank profitability on balance benefited despite the squeeze on margins, thanks to fewer loans going bad, higher economic growth and an increase in asset values.
Negative rates come with all the downsides of loose monetary policy generally, such as boosting wealth inequality and encouraging businesses and households to take on debt. Low yields can prompt excessive risk-taking. Yet negative rates avoid some of the market pressures created by quantitative easing as the central bank does not get involved in asset markets directly. The Federal Reserve’s purchase of junk bonds, for example, is criticised for distorting “real” prices.
Rather than tout negative rates, though, politicians such as Mr Trump would do better to take on some of the burden from central banks. Fiscal stimulus from governments can be better targeted to those who most need help and have the highest propensity to spend. Negative interest rates in the eurozone were partly a response to politicians’ failures to launch either sufficient fiscal stimulus or reform. The US and UK can learn from their mistakes.